QUARTERLY
REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For quarterly period ended June 30, 2012

£

TRANSITION
REPORT UNDER SECTION
13 OR 15(d) OF THE
EXCHANGE ACT

For the transition period from _______________ to
________________

Commission file number 0-14237

First United Corporation

(Exact name of registrant as specified
in its charter)

Maryland

52-1380770

(State or other jurisdiction of

(I. R. S. Employer Identification No.)

incorporation or organization)

19 South Second Street, Oakland, Maryland
21550-0009

(Address of principal executive offices)
(Zip Code)

(800) 470-4356

(Registrant's telephone number, including
area code)

Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes R
No £

Indicate by check mark whether the registrant
has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes R
No £

Indicate by check mark
whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.
See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company”
in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer £

Accelerated filer £

Non-accelerated filer £
(Do not check if a smaller reporting company)

Smaller reporting company R

Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes £
No R

Indicate the number of
shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 6,199,283 shares
of common stock, par value $.01 per share, as of July 31, 2012.

INDEX TO QUARTERLY REPORT

FIRST UNITED CORPORATION

PART I. FINANCIAL INFORMATION

3

Item 1.

Financial Statements (unaudited)

3

Consolidated Statements of Financial Condition – June 30, 2012 and December 31, 2011

3

Consolidated Statements of Operations - for the three and six months ended June 30, 2012 and 2011

4-5

Consolidated Statements of Comprehensive Income/(Loss) – for the three and six months ended June 30, 2012 and 2011

6-7

Consolidated Statements of Changes in Shareholders’ Equity - for the six months ended June 30, 2012 and year ended
December 31, 2011

8

Consolidated Statements of Cash Flows - for the six months ended June 30, 2012 and 2011

9

Notes to Consolidated Financial Statements

10

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

39

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

60

Item 4.

Controls and Procedures

61

PART II. OTHER INFORMATION

61

Item 1.

Legal Proceedings

61

Item 1A.

Risk Factors

61

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

61

Item 3.

Defaults upon Senior Securities

61

Item 4.

Mine Safety Disclosures

61

Item 5.

Other Information

61

Item 6.

Exhibits

61

SIGNATURES

62

EXHIBIT INDEX

63

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FIRST UNITED CORPORATION

Consolidated Statements of Financial Condition

(In thousands, except per share and percentage
data)

June 30, 2012

December 31,
2011

(Unaudited)

Assets

Cash and due from banks

$

53,305

$

52,049

Interest bearing deposits in banks

13,634

13,058

Cash and cash equivalents

66,939

65,107

Investment securities – available-for-sale (at fair value)

227,244

245,023

Investment securities – held to maturity (at cost)

4,040

0

Restricted investment in bank stock, at cost

9,679

10,726

Loans

907,909

938,694

Allowance for loan losses

(16,770

)

(19,480

)

Net loans

891,139

919,214

Premises and equipment, net

30,378

30,826

Goodwill and other intangible assets, net

11,004

14,432

Bank owned life insurance

30,893

31,435

Deferred tax assets

30,054

28,711

Other real estate owned

19,828

16,676

Accrued interest receivable and other assets

27,241

28,715

Total Assets

$

1,348,439

$

1,390,865

Liabilities and Shareholders’ Equity

Liabilities:

Non-interest bearing deposits

$

157,324

$

149,888

Interest bearing deposits

839,016

877,896

Total deposits

996,340

1,027,784

Short-term borrowings

28,902

36,868

Long-term borrowings

206,515

207,044

Accrued interest payable and other liabilities

21,579

22,513

Total Liabilities

1,253,336

1,294,209

Shareholders’ Equity:

Preferred stock – no par value;

Authorized 2,000 shares of which 30 shares of Series
A, $1,000 per share liquidation preference, 5% cumulative increasing to 9%cumulative on February 15, 2014, were issued and
outstanding on June 30, 2012 and December 31, 2011 (discount of $108 and $140, respectively)

29,892

29,860

Common Stock – par value $.01 per share;

Authorized 25,000 shares; issued and outstanding 6,199 shares at June
30, 2012 and 6,183 shares at December 31, 2011

62

62

Surplus

21,531

21,500

Retained earnings

64,334

66,196

Accumulated other comprehensive loss

(20,716

)

(20,962

)

Total Shareholders’ Equity

95,103

96,656

Total Liabilities and Shareholders’ Equity

$

1,348,439

$

1,390,865

See accompanying notes to the consolidated
financial statements

3

FIRST UNITED CORPORATION

Consolidated Statements of Operations

(In thousands, except per share data)

Six Months Ended June 30,

2012

2011

(Unaudited)

Interest income

Interest and fees on loans

$

23,954

$

27,163

Interest on investment securities

Taxable

2,145

1,795

Exempt from federal income tax

1,036

1,552

Total investment income

3,181

3,347

Other

134

239

Total interest income

27,269

30,749

Interest expense

Interest on deposits

3,558

6,903

Interest on short-term borrowings

97

127

Interest on long-term borrowings

3,833

4,701

Total interest expense

7,488

11,731

Net interest income

19,781

19,018

Provision for loan losses

9,236

4,605

Net interest income after provision for loan losses

10,545

14,413

Other operating income

Changes in fair value on impaired securities

(43

)

793

Portion of loss/(gain) recognized
in other comprehensive income (before taxes)

43

(812

)

Net securities impairment losses recognized in operations

0

(19

)

Net gains – other

1,362

668

Total net gains

1,362

649

Service charges

1,725

1,803

Trust department

2,269

2,143

Insurance commissions

8

1,288

Debit card income

1,021

1,112

Bank owned life insurance

1,264

509

Other

911

725

Total other income

7,198

7,580

Total other operating income

8,560

8,229

Other operating expenses

Salaries and employee benefits

9,936

10,158

FDIC premiums

977

1,387

Equipment

1,341

1,575

Occupancy

1,401

1,425

Data processing

1,445

1,387

Other

4,849

5,071

Total other operating expenses

19,949

21,003

(Loss)/Income before income tax expense

(844

)

1,639

Applicable income tax expense/(benefit)

172

(451

)

Net (Loss)/Income

(1,016

)

2,090

Accumulated preferred stock dividends and discount
accretion

(846

)

(794

)

Net (Loss) Attributable to/Net Income Available to
Common Shareholders

$

(1,862

)

$

1,296

Basic net (loss)/income per common share

$

(.30

)

$

.21

Diluted net (loss)/income per common share

$

(.30

)

$

.21

Weighted average number of basic and diluted shares outstanding

6,188

6,172

See accompanying notes to the consolidated
financial statements

4

FIRST UNITED CORPORATION

Consolidated Statements of Operations

(In thousands, except per share data)

Three Months Ended June 30,

2012

2011

(Unaudited)

Interest income

Interest and fees on loans

$

11,905

$

13,249

Interest on investment securities

Taxable

1,040

1,090

Exempt from federal income tax

481

690

Total investment income

1,521

1,780

Other

75

92

Total interest income

13,501

15,121

Interest expense

Interest on deposits

1,665

3,232

Interest on short-term borrowings

51

66

Interest on long-term borrowings

1,887

2,275

Total interest expense

3,603

5,573

Net interest income

9,898

9,548

Provision for loan losses

1,112

3,261

Net interest income after provision for loan losses

8,786

6,287

Other operating income

Changes in fair value on impaired securities

(371

)

102

Portion of loss/(gain) recognized
in other comprehensive income (before taxes)

The accompanying unaudited
consolidated financial statements of First United Corporation and its consolidated subsidiaries, including First United Bank &
Trust (the “Bank”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”)
for interim financial information, as required by the Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (“ASC”) Topic 270, Interim Reporting, and with the instructions to Form 10-Q and Rule 8-03 of
Regulation S-X. Accordingly, they do not include all the information and footnotes required for annual financial statements. In
the opinion of management, all adjustments considered necessary for a fair presentation, consisting of normal recurring items,
have been included. Operating results for the three- and six- month periods ended June 30, 2012 are not necessarily indicative
of the results that may be expected for the full year or for any future interim period. These consolidated financial statements
should be read in conjunction with the audited consolidated financial statements and notes thereto included in First United Corporation’s
Annual Report on Form 10-K for the year ended December 31, 2011. For purposes of comparability, certain prior period amounts have
been reclassified to conform to the 2012 presentation. Such reclassifications had no impact on net income/(loss) or equity.

First United Corporation
has evaluated events and transactions occurring subsequent to the statement of financial condition date of June 30, 2012 for items
that should potentially be recognized or disclosed in these financial statements as prescribed by ASC Topic 855, Subsequent
Events.

As used in these notes
to consolidated financial statements, First United Corporation and its consolidated subsidiaries are sometimes collectively referred
to as the “Corporation”.

Note 2 – (Loss)/Earnings Per Common Share

Basic earnings/(loss)
per common share is derived by dividing net income available to/(loss) attributable to common shareholders by the weighted-average
number of common shares outstanding during the period and does not include the effect of any potentially dilutive common stock
equivalents. Diluted earnings/(loss) per share is derived by dividing net income available to/(loss) attributable to common shareholders
by the weighted-average number of shares outstanding, adjusted for the dilutive effect of outstanding common stock equivalents.
There were no common stock equivalents during the three- and six-months ended June 30, 2012 and June 30, 2011. There is no dilutive
effect on the earnings per share during loss periods.

The following table
sets forth the calculation of basic and diluted earnings/(loss) per common share for the six- and three-month periods ended June
30, 2012 and 2011:

For the six months ended June 30,

2012

2011

(in thousands, except for per share amount)

Loss

Average Shares

Per Share
Amount

Income

Average Shares

Per Share
Amount

Basic and Diluted (Loss)/Earnings Per Share:

Net (loss)/income

$

(1,016

)

$

2,090

Preferred stock dividends deferred

(814

)

(764

)

Discount accretion on preferred stock

(32

)

(30

)

Net (loss) attributable to/income available
to common shareholders

$

(1,862

)

6,188

$

(.30

)

$

1,296

6,172

$

.21

10

For the three months ended June 30,

2012

2011

(in thousands, except for per share amount)

Income

Average Shares

Per Share
Amount

Income

Average Shares

Per Share
Amount

Basic and Diluted Earnings Per Share:

Net income

$

1,649

$

1,133

Preferred stock dividends deferred

(415

)

(385

)

Discount accretion on preferred stock

(16

)

(15

)

Net income available to common shareholders

$

1,218

6,194

$

.20

$

733

6,177

$

.12

Note 3 – Net Gains

The following table
summarizes the gain/(loss) activity for the six- and three-month periods ended June 30, 2012 and 2011:

Six months ended June 30,

(in thousands)

2012

2011

Other-than-temporary impairment charges:

Available-for-sale securities

$

0

$

(19

)

Net gains/(losses) – other:

Available-for-sale securities:

Realized gains

663

367

Realized losses

(64

)

(101

)

Gain/(loss) on sales of other real estate owned

682

(44

)

Write-down of other real estate owned

0

(952

)

Gain on sale of consumer loans

59

41

Gain on sale of insurance assets

88

0

Gain on sale of indirect auto loans

0

1,366

Loss on disposal of fixed assets

(66

)

(9

)

Net gains – other

1,362

668

Net gains

$

1,362

$

649

Three months ended June 30,

(in thousands)

2012

2011

Other-than-temporary impairment charges:

Available-for-sale securities

$

0

$

0

Net gains/(losses) – other:

Available-for-sale securities:

Realized gains

0

130

Realized losses

0

(19

)

Gain/(loss) on sales of other real estate owned

59

(37

)

Write-down of other real estate owned

0

(889

)

Gain on sale of consumer loans

39

22

Gain on sale of insurance assets

0

0

Gain on sale of indirect auto loans

0

1,366

Loss on disposal of fixed assets

(62

)

(6

)

Net gains – other

36

567

Net gains

$

36

$

567

11

Note 4 – Cash and Cash Equivalents

Cash and due from
banks, which represents vault cash in the retail offices and invested cash balances at the Federal Reserve, is carried at fair
value.

June 30, 2012

December
31, 2011

Cash and due from banks, weighted average
interest rate of 0.18% (at June 30, 2012)

$

53,305

$

52,049

Interest bearing deposits
in banks, which represent funds invested at a correspondent bank, are carried at fair value and, as of June 30, 2012 and December
31, 2011, consisted of daily funds invested at the Federal Home Loan Bank (“FHLB”) of Atlanta, First Tennessee Bank
(“FTN”), Merchants and Traders (“M&T”) and Community Bankers Bank (“CBB”).

June 30, 2012

December
31, 2011

FHLB daily investments, interest rate of 0.05% (at June 30, 2012)

$

5,169

$

4,244

FTN daily investments, interest rate of 0.09% (at June 30, 2012)

1,350

1,350

M&T daily investments, interest rate of 0.25% (at June 30, 2012)

6,030

6,379

CBB Fed Funds sold, interest rate of 0.21% (at June 30, 2012)

1,085

1,085

$

13,634

$

13,058

Note 5 – Investments

The investment portfolio
is classified and accounted for based on the guidance of ASC Topic 320, Investments – Debt and Equity Securities.

The
amortized cost of debt securities classified as available-for-sale is adjusted for the amortization of premiums to the first call
date, if applicable, or to maturity, and for the accretion of discounts to maturity, or, in
the case of mortgage-backed securities, over the estimated life of the security. Such amortization and accretion is included in
interest income from investments. Interest and dividends are included in interest income from investments. Gains and losses on
the sale of securities are recorded using the specific identification method.

12

The following table
shows a comparison of amortized cost and fair values of investment securities at June 30, 2012 and December 31, 2011:

(in thousands)

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Fair Value

OTTI in AOCI

June 30, 2012

Available for Sale:

U.S. government agencies

$

25,515

$

69

$

87

$

25,497

$

0

Residential mortgage-backed agencies

84,715

1,523

154

86,084

0

Commercial mortgage-backed agencies

48,343

1,011

51

49,303

0

Collateralized mortgage obligations

643

0

42

601

0

Obligations of states and political subdivisions

53,253

3,177

10

56,420

0

Collateralized debt obligations

36,581

0

27,242

9,339

17,769

Total available for sale

$

249,050

$

5,780

$

27,586

$

227,244

$

17,769

Held to Maturity:

Obligations of states and political subdivisions

$

4,040

$

0

$

0

$

4,040

$

0

December 31, 2011

U.S. government agencies

$

25,490

$

107

$

17

$

25,580

$

0

Residential mortgage-backed agencies

94,332

1,494

135

95,691

0

Commercial mortgage-backed agencies

44,850

217

135

44,932

0

Collateralized mortgage obligations

680

0

123

557

0

Obligations of states and political subdivisions

65,424

3,400

8

68,816

0

Collateralized debt obligations

36,385

0

26,938

9,447

17,726

Totals

$

267,161

$

5,218

$

27,356

$

245,023

$

17,726

Proceeds from sales
of securities and the realized gains and losses are as follows:

Six Months Ended June 30,

Three Months Ended June 30,

(in thousands)

2012

2011

2012

2011

Proceeds

$

10,454

$

29,115

$

0

$

7,067

Realized gains

663

367

0

130

Realized losses

64

101

0

19

The following table
shows the Corporation’s securities with gross unrealized losses and fair values at June 30, 2012 and December 31, 2011,
aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

Less than 12
months

12 months or more

(in thousands)

Fair Value

Unrealized Losses

Fair Value

Unrealized Losses

June 30, 2012

U.S. government agencies

$

16,934

$

87

$

0

$

0

Residential mortgage-backed agencies

16,900

154

0

0

Commercial mortgage-backed agencies

0

0

6,008

51

Collateralized mortgage obligations

0

0

601

42

Obligations of states and political subdivisions

3,693

10

0

0

Collateralized debt obligations

0

0

9,339

27,242

Totals

$

37,527

$

251

$

15,948

$

27,335

December 31, 2011

U.S. government agencies

$

9,983

$

17

$

0

$

0

Residential mortgage-backed agencies

30,225

134

4,779

1

Commercial mortgage-backed agencies

16,975

135

0

0

Collateralized mortgage obligations

0

0

557

123

Obligations of states and political subdivisions

0

0

2,805

8

Collateralized debt obligations

0

0

9,447

26,938

Totals

$

57,183

$

286

$

17,588

$

27,070

13

Management
systematically evaluates securities for impairment on a quarterly basis. Management assesses whether (a) it has the intent
to sell a security being evaluated and (b) it is more likely than not that the Corporation will be required to sell the security
prior to its anticipated recovery. If neither applies, then declines in the fair values of securities below their cost that are
considered other-than-temporary declines are split into two components. The first is the loss attributable to declining credit
quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made.
The second component consists of all other losses, which are recognized in other comprehensive loss. In estimating other-than-temporary
impairment (“OTTI”) losses, management considers (1) the length of time and the extent to which the fair value has
been less than cost, (2) adverse conditions specifically related to the security, an industry, or a geographic area, (3) the historic
and implied volatility of the fair value of the security, (4) changes in the rating of the security by a rating agency, (5) recoveries
or additional declines in fair value subsequent to the balance sheet date, (6) failure of the issuer of the security to make scheduled
interest or principal payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able
to make payments that increase in the future. Management also monitors cash flow projections for securities that are considered
beneficial interests under the guidance of ASC Subtopic 325-40, Investments – Other – Beneficial Interests in Securitized
Financial Assets, (ASC Section 325-40-35). Further discussion about the evaluation of securities for impairment can be found
in Item 2 of Part I of this report under the heading “Investment Securities”.

Management believes
that the valuation of certain securities is a critical accounting policy that requires significant estimates in preparation of
its consolidated financial statements. Management utilizes an independent third party to prepare both the impairment valuations
and fair value determinations for its collateralized debt obligation (“CDO”) portfolio consisting of pooled trust
preferred securities. Based on management’s review of the assumptions and results of the third-party review, it does not
believe that there were any material differences in the valuations between June 30, 2012 and December 31, 2011.

U.S. Government
Agencies - Three U.S. government agencies have been in a slight unrealized loss position for less than 12 months as of June
30, 2012. The securities are of the highest investment grade and the Corporation does not intend to sell them, and it is not more
likely than not that the Corporation will be required to sell them before recovery of their amortized cost basis, which may be
at maturity. Therefore, no OTTI exists at June 30, 2012.

Residential Mortgage-Backed
Agencies - Five residential mortgage-backed agencies have been in a slight unrealized loss position for less than 12 months
as of June 30, 2012. There were no residential mortgage-backed agency securities in an unrealized loss position for 12 months
or more. The securities are of the highest investment grade and the Corporation does not intend to sell them, and it is not more
likely than not that the Corporation will be required to sell the securities before recovery of their amortized cost basis, which
may be at maturity. Therefore, no OTTI exists at June 30, 2012.

Commercial Mortgage-Backed
Agencies - No commercial mortgage-backed agencies were in an unrealized loss position for less than 12 months as of June 30,
2012. There was one commercial mortgage-backed agency security in an unrealized loss position for 12 months or more. The security
is of the highest investment grade and the Corporation does not intend to sell the security, and it is not more likely than not
that the Corporation will be required to sell the security before recovery of their amortized cost basis, which may be at maturity.
Therefore, no OTTI exists at June 30, 2012.

14

Collateralized
Mortgage Obligations – The collateralized mortgage obligation portfolio consisted of one security at June 30, 2012 that
has been in an unrealized loss position for 12 months or more. The security with an unrealized loss of greater than 12 months
is a private label residential mortgage-backed security and is reviewed for factors such as loan to value ratio, credit support
levels, borrower FICO scores, geographic concentration, prepayment speeds, delinquencies, coverage ratios and credit ratings.
Management believes that this security continues to demonstrate collateral coverage ratios that are adequate to support the Corporation’s
investment. At the time of purchase, this security was of the highest investment grade and was purchased at a discount relative
to its face amount. As of June 30, 2012, this security remains at investment grade and continues to perform as expected at the
time of purchase. The Corporation does not intend to sell this security and it is not more likely than not that the Corporation
will be required to sell the investment before recovery of its amortized cost basis, which may be at maturity. Accordingly, management
does not consider this investment to be other-than-temporarily impaired at June 30, 2012.

Obligations of
State and Political Subdivisions – The unrealized losses on the Corporation’s investments in state and political
subdivisions were $9,759 at June 30, 2012. One security has been in an unrealized loss position for less than 12 months. There
are no securities that have been in an unrealized loss position for 12 months or more. This investment is of investment grade
as determined by the major rating agencies and management reviews the ratings of the underlying issuers. Management believes that
this portfolio is well-diversified throughout the United States, and all bonds continue to perform according to their contractual
terms. The Corporation does not intend to sell this investment and it is not more likely than not that the Corporation will be
required to sell the investment before recovery of its amortized cost basis, which may be at maturity. Accordingly, management
does not consider this investment to be other-than-temporarily impaired at June 30, 2012.

Collateralized
Debt Obligations - The $27.2 million in unrealized losses greater than 12 months at June 30, 2012 relates to 18 pooled trust
preferred securities that comprise the CDO portfolio. See Note 8 for a discussion of the methodology used by management to determine
the fair values of these securities. Based upon a review of credit quality and the cash flow tests performed by the independent
third party, management determined that there were no securities that had credit-related non-cash OTTI charges during the first
half of 2012. The unrealized losses on the remaining securities in the portfolio are primarily attributable to continued depression
in market interest rates, marketability, liquidity and the current economic environment.

The following tables
present a cumulative roll-forward of the amount of non-cash OTTI charges related to credit losses which have been recognized in
earnings for the trust preferred securities in the CDO portfolio held and not intended to be sold for the three- and six- month
periods ended June 30, 2012 and 2011:

Six months ended

(in thousands)

June 30,
2012

June 30,
2011

Balance of credit-related OTTI at January 1

$

14,424

$

14,653

Additions for credit-related OTTI not previously recognized

0

0

Additional increases for credit-related OTTI previously recognized when there is no Intent to
sell and no requirement to sell before recovery of amortized cost basis

0

19

Decreases for previously recognized credit-related OTTI because there was an Intent to sell

0

0

Reduction for increases in cash flows expected to be collected

(224

)

(101

)

Balance of credit-related OTTI at June 30

$

14,200

$

14,571

Three months ended

(in thousands)

June 30,
2012

June 30,
2011

Balance of credit-related OTTI at April 1

$

14,312

$

14,617

Additions for credit-related OTTI not previously recognized

0

0

Additional increases for credit-related OTTI previously recognized when there is no intent to
sell and no requirement to sell before recovery of amortized cost basis

0

0

Decreases for previously recognized credit-related OTTI because there was an intent to sell

0

0

Reduction for increases in cash flows expected to be collected

(112

)

(46

)

Balance of credit-related OTTI at June 30

$

14,200

$

14,571

The amortized cost
and estimated fair value of securities by contractual maturity at June 30, 2012 is shown in the following table. Actual maturities
will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations
with or without call or prepayment penalties.

15

June 30, 2012

(in thousands)

Amortized Cost

Fair Value

Contractual Maturity

Available for sale:

Due in one year or less

$

0

$

0

Due after one year through five years

0

0

Due after five years through ten years

45,911

47,098

Due after ten years

69,438

44,158

115,349

91,256

Residential mortgage-backed agencies

84,715

86,084

Commercial mortgage-backed agencies

48,343

49,303

Collateralized mortgage obligations

643

601

$

249,050

$

227,244

Held to Maturity:

Due after ten years

$

4,040

$

4,040

Note 6 - Restricted Investment in Bank
Stock

Restricted stock,
which represents required investments in the common stock of the FHLB of Atlanta, Atlantic Central Bankers Bank (“ACBB”)
and CBB, is carried at cost and is considered a long-term investment.

Management evaluates
the restricted stock for impairment in accordance with ASC Industry Topic 942, Financial Services – Depository and Lending,
(ASC Section 942-325-35). Management’s evaluation of potential
impairment is based on management’s assessment of the ultimate recoverability of the cost of the restricted stock
rather than by recognizing temporary declines in value. The determination
of whether a decline affects the ultimate recoverability is influenced by criteria such as (a) the significance of the decline
in net assets of the issuing bank as compared to the capital stock amount for that bank and the length of time this situation
has persisted, (b) commitments by the issuing bank to make payments required by law or regulation and the level of such payments
in relation to the operating performance of that bank, and (c) the impact of legislative and regulatory changes on institutions
and, accordingly, on the customer base of the issuing bank. Management has evaluated the restricted stock for impairment
and believes that no impairment charge is necessary as of June 30, 2012.

The Corporation recognizes
dividends on a cash basis. For the six months ended June 30, 2012, dividends of $73,867 were recognized in earnings. For the comparable
period of 2011, dividends of $49,700 were recognized in earnings.

Note 7 – Loans
and Related Allowance for Loan Losses

The following table
summarizes the primary segments of the loan portfolio as of June 30, 2012 and December 31, 2011:

(in thousands)

Commercial Real Estate

Acquisition and Development

Commercial and Industrial

Residential Mortgage

Consumer

Total

June 30, 2012

Total loans

$

318,073

$

138,825

$

66,626

$

350,983

$

33,402

$

907,909

Individually evaluated for impairment

$

14,772

$

24,607

$

4,038

$

6,276

$

42

$

49,735

Collectively evaluated for impairment

$

303,301

$

114,218

$

62,588

$

344,707

$

33,360

$

858,174

December 31, 2011

Total loans

$

336,234

$

142,871

$

78,697

$

347,220

$

33,672

$

938,694

Individually evaluated for impairment

$

16,942

$

25,699

$

13,048

$

6,116

$

21

$

61,826

Collectively evaluated for impairment

$

319,292

$

117,172

$

65,649

$

341,104

$

33,651

$

876,868

16

The segments of the
Bank’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. The commercial
real estate (“CRE”) loan segment is then segregated into two classes. Non-owner occupied CRE loans, which include loans
secured by non-owner occupied, nonfarm, and nonresidential properties, generally have a greater risk profile than all other CRE
loans, which include loans secured by farmland, multifamily structures and owner-occupied commercial structures. The acquisition
and development (“A&D”) loan segment is segregated into two classes. One-to-four family residential construction
loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling
is to be built. All other A&D loans are generally made to developers or investors for the purpose of acquiring, developing
and constructing residential or commercial structures. These loans have a higher risk profile because the ultimate buyer, once
development is completed, is generally not known at the time of the A&D loan. The commercial and industrial (“C&I”)
loan segment consists of loans made for the purpose of financing the activities of commercial customers. The residential mortgage
loan segment is segregated into two classes: (a) amortizing term loans, which are primarily first liens; and (b) home equity lines
of credit, which are generally second liens. The consumer loan segment consists primarily of installment loans (direct and indirect)
and overdraft lines of credit connected with customer deposit accounts.

Management uses a 10-point
internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered
not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally
follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially
weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans
in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility
that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard.
The portion of a specific allocation of the allowance for loan losses that management believes is associated with a pending event
that could trigger loss in the short-term will be classified in the Doubtful category. Any portion of a loan that has been charged
off is placed in the Loss category.

To help ensure that
risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured
loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans
are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness
of a possible credit event. The Bank’s Commercial Loan Officers are responsible for the timely and accurate risk rating of
the loans in the commercial segments at origination and on an ongoing basis. The Bank’s experienced Credit Quality and Loan
Review Department performs an annual review of all commercial relationships $500,000 or greater. Confirmation of the appropriate
risk grade is included as part of the review process on an ongoing basis. The Credit Quality and Loan Review Department continually
reviews and assesses loans within the portfolio. In addition, the Bank engages an external consultant to conduct loan reviews on
at least an annual basis. Generally, the external consultant reviews commercial relationships greater than $750,000 and/or criticized
relationships greater than $500,000. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard
on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are
given separate consideration in the determination of the allowance.

The following table
presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard
and Doubtful within the internal risk rating system as of June 30, 2012 and December 31, 2011:

17

(in thousands)

Pass

Special Mention

Substandard

Doubtful

Total

June 30, 2012

Commercial real estate

Non owner-occupied

$

117,251

$

7,467

$

24,261

$

0

$

148,979

All other CRE

120,870

10,611

37,613

0

169,094

Acquisition and development

1-4 family residential construction

10,226

1,550

5,075

0

16,851

All other A&D

79,160

924

41,890

0

121,974

Commercial and industrial

57,580

2,372

6,674

0

66,626

Residential mortgage

Residential mortgage - term

257,047

2,453

11,803

0

271,303

Residential mortgage – home equity

77,102

793

1,785

0

79,680

Consumer

33,070

29

303

0

33,402

Total

$

752,306

$

26,199

$

129,404

$

0

$

907,909

December 31, 2011

Commercial real estate

Non owner-occupied

$

119,574

$

4,222

$

32,212

$

0

$

156,008

All other CRE

123,713

18,307

38,206

0

180,226

Acquisition and development

1-4 family residential construction

11,512

0

5,572

0

17,084

All other A&D

81,268

935

43,584

0

125,787

Commercial and industrial

62,152

697

15,848

0

78,697

Residential mortgage

Residential mortgage - term

250,701

1,817

15,408

0

267,926

Residential mortgage – home equity

75,517

34

3,743

0

79,294

Consumer

33,147

34

491

0

33,672

Total

$

757,584

$

26,046

$

155,064

$

0

$

938,694

Management further
monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length
of time a recorded payment is past due. A loan is considered to be past due when a payment has not been received for 30 days past
its contractual due date. For all loan segments, the accrual of interest is discontinued when principal or interest is delinquent
for 90 days or more unless the loan is well-secured and in the process of collection. All non-accrual loans are considered to be
impaired. Interest payments received on non-accrual loans are applied as a reduction of the loan principal balance. Loans are returned
to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably
assured. The Corporation’s policy for recognizing interest income on impaired loans does not differ from its overall policy
for interest recognition.

18

The following table
presents the classes of the loan portfolio summarized by the aging categories of performing loans and non-accrual loans as of June
30, 2012 and December 31, 2011:

(in thousands)

Current

30-59 Days Past
Due

60-89 Days Past
Due

90 Days+ Past
Due

Total Past Due
and still accruing

Non- Accrual

Total Loans

June 30, 2012

Commercial real estate

Non owner-occupied

$

140,271

$

2,069

$

205

$

0

$

2,274

$

6,434

$

148,979

All other CRE

162,084

162

5,185

0

5,347

1,663

169,094

Acquisition and development

1-4 family residential construction

16,851

0

0

0

0

0

16,851

All other A&D

103,578

3,387

143

97

3,627

14,769

121,974

Commercial and industrial

66,065

160

91

0

251

310

66,626

Residential mortgage

Residential mortgage - term

261,793

878

3,958

1,553

6,389

3,121

271,303

Residential mortgage – home equity

78,378

524

100

0

624

678

79,680

Consumer

32,124

878

260

98

1,236

42

33,402

Total

$

861,144

$

8,058

$

9,942

$

1,748

$

19,748

$

27,017

$

907,909

December 31, 2011

Commercial real estate

Non owner-occupied

$

146,150

$

359

$

209

$

0

$

568

$

9,290

$

156,008

All other CRE

173,342

558

5,547

0

6,105

779

180,226

Acquisition and development

1-4 family residential construction

17,009

0

75

0

75

0

17,084

All other A&D

109,351

840

530

128

1,498

14,938

125,787

Commercial and industrial

69,119

182

32

0

214

9,364

78,697

Residential mortgage

Residential mortgage - term

249,719

10,106

3,753

1,386

15,245

2,962

267,926

Residential mortgage – home equity

77,486

476

375

123

974

834

79,294

Consumer

31,478

1,560

471

142

2,173

21

33,672

Total

$

873,654

$

14,081

$

10,992

$

1,779

$

26,852

$

38,188

$

938,694

Non-accrual loans which
have been subject to a partial charge-off totaled $11.5 million as of June 30, 2012, compared to $13.4 million as of December 31,
2011.

An allowance for loan
losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing
evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification
and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

The Bank’s methodology
for determining the ALL is based on the requirements of ASC Section 310-10-35, Receivables-Overall-Subsequent Measurement,
for loans individually evaluated for impairment and ASC Subtopic 450-20, Contingencies-Loss Contingencies, for loans
collectively evaluated for impairment, as well as the Interagency Policy Statement on the Allowance for Loan and Lease Losses and
other bank regulatory guidance. The total of the two components represents the Bank’s ALL.

19

The following table
summarizes the primary segments of the ALL, segregated by the amount required for loans individually evaluated for impairment and
the amount required for loans collectively evaluated for impairment as of June 30, 2012 and December 31, 2011.

(In thousands)

Commercial
Real Estate

Acquisition and Development

Commercial
and Industrial

Residential Mortgage

Consumer

Total

June 30, 2012

Total ALL

$

5,856

$

6,209

$

860

$

3,457

$

388

$

16,770

Individually evaluated for impairment

$

15

$

1,582

$

0

$

19

$

0

$

1,616

Collectively evaluated for impairment

$

5,841

$

4,627

$

860

$

3,438

$

388

$

15,154

December 31, 2011

Total ALL

$

6,218

$

7,190

$

2,190

$

3,430

$

452

$

19,480

Individually evaluated for impairment

$

92

$

2,718

$

1,139

$

2

$

0

$

3,951

Collectively evaluated for impairment

$

6,126

$

4,472

$

1,051

$

3,428

$

452

$

15,529

Management evaluates
individual loans in all of the commercial segments for possible impairment, if the loan is greater than $500,000 or is part of
a relationship that is greater than $750,000 and is either (a) in nonaccrual status or (b) risk-rated Substandard and greater than
60 days past due. Loans are considered to be impaired when, based on current information and events, it is probable that the Bank
will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in evaluating impairment include payment status, collateral value, and the probability
of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and
payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the
shortfall in relation to the principal and interest owed. The Bank does not separately evaluate individual consumer and residential
mortgage loans for impairment, unless such loans are part of larger relationship that is impaired; otherwise loans in these segments
are considered impaired when they are classified as non-accrual.

Once the determination
has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured
by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value
of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price;
or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis, with management primarily
utilizing the fair value of collateral method. If the fair value of the collateral less selling costs method is utilized for collateral
securing loans in the commercial segments, then an updated external appraisal is ordered on the collateral supporting the loan
if the loan balance is greater than $500,000 and the existing appraisal is greater than 18 months old. If an appraisal is less
than 12 months old (the age at which the internal appraisal grid begins) and if management believes that general market conditions
in that geographic market have changed considerably, the property has deteriorated or perhaps lost an income stream, or a recent
appraisal for a similar property indicates a significant change, then management may adjust the fair value indicated by the existing
appraisal until a new appraisal is obtained. If the most recent appraisal is greater than 12 months old or if an updated appraisal
has not been received and reviewed in time for the determination of estimated fair value at quarter (or year) end, then the estimated
fair value of the collateral is determined by adjusting the existing appraisal by the appropriate percentage from an internally
prepared appraisal discount grid. This grid considers the age of a third party appraisal and the geographic region where the collateral
is located in order to discount an appraisal that is greater than 12 months old. The discount rates in the appraisal discount grid
are updated quarterly to reflect the most current knowledge that management has available, including the results of current appraisals.
If there is a delay in receiving an updated appraisal or if the appraisal is found to be deficient in our internal appraisal review
process and re-ordered, then the Bank continues to use a discount factor from the appraisal discount grid based on the collateral
location and current appraisal age in order to determine the estimated fair value. A specific allocation of the ALL is recorded
if there is any deficiency in collateral value determined by comparing the estimated fair value to the recorded investment of the
loan. When updated appraisals are received and reviewed, adjustments are made to the specific allocation as needed.

The evaluation of the
need and amount of a specific allocation of the ALL and whether a loan can be removed from impairment status is made on a quarterly
basis.

20

The following table
presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific
allowance was not necessary as of June 30, 2012 and December 31, 2011:

Impaired Loans with Specific Allowance

Impaired Loans with No Specific Allowance

Total Impaired Loans

(in thousands)

Recorded
Investment

Related
Allowance

Recorded
Investment

Recorded
Investment

Unpaid
Principal
Balance

June 30, 2012

Commercial real estate

Non owner-occupied

$

145

$

15

$

6,568

$

6,713

$

10,226

All other CRE

0

0

8,059

8,059

8,268

Acquisition and development

1-4 family residential construction

2,128

905

0

2,128

2,128

All other A&D

5,600

677

16,879

22,479

26,931

Commercial and industrial

0

0

4,038

4,038

4,127

Residential mortgage

Residential mortgage - term

291

19

5,058

5,349

5,545

Residential mortgage – home equity

0

0

927

927

977

Consumer

0

0

42

42

51

Total impaired loans

$

8,164

$

1,616

$

41,571

$

49,735

$

58,253

December 31, 2011

Commercial real estate

Non owner-occupied

$

448

$

92

$

9,129

$

9,577

$

14,765

All other CRE

0

0

7,365

7,365

7,390

Acquisition and development

1-4 family residential construction

2,489

859

0

2,489

2,577

All other A&D

7,850

1,859

15,360

23,210

27,712

Commercial and industrial

9,043

1,139

4,005

13,048

13,137

Residential mortgage

Residential mortgage - term

218

2

4,816

5,034

5,488

Residential mortgage – home equity

0

0

1,082

1,082

1,177

Consumer

0

0

21

21

33

Total impaired loans

$

20,048

$

3,951

$

41,778

$

61,826

$

72,279

Loans that are collectively
evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss
trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative
factors.

The classes described
above, which are based on the Federal call code assigned to each loan, provide the starting point for the ALL analysis. Management
tracks the historical net charge-off activity (full and partial charge-offs, net of full and partial recoveries) at the call code
level. A historical charge-off factor is calculated utilizing a defined number of consecutive historical quarters. Consumer pools
currently utilize a rolling 12 quarters, while Commercial pools currently utilize a rolling eight quarters.

21

“Pass”
rated credits are segregated from “Criticized” credits for the application of qualitative factors. The un-criticized
(“pass”) pools for commercial and residential real estate are further segmented based upon the geographic location
of the underlying collateral. There are seven geographic regions utilized – six that represent the Bank’s lending footprint
and a seventh for all out-of-market credits. Different economic environments and resultant credit risks exist in each region that
are acknowledged in the assignment of qualitative factors. Loans in the criticized pools, which possess certain qualities or characteristics
that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors.

Management supplements
the historical charge-off factor with a number of additional qualitative factors that are likely to cause estimated credit losses
associated with the existing loan pools to differ from historical loss experience. The additional factors, which are evaluated
quarterly and updated using information obtained from internal, regulatory, and governmental sources, are: (a) national and local
economic trends and conditions; (b) levels of and trends in delinquency rates and non-accrual loans; (c) trends in volumes and
terms of loans; (d) effects of changes in lending policies; (e) experience, ability, and depth of lending staff; (f) value of underlying
collateral; and (g) concentrations of credit from a loan type, industry and/or geographic standpoint.

Management reviews
the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments
to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off
against the ALL. Residential mortgage and consumer loans are charged off after they are 120 days contractually past due. All other
loans are charged off based on an evaluation of the facts and circumstances of each individual loan. When the Bank believes that
its ability to collect is solely dependent on the liquidation of the collateral, a full or partial charge-off is recorded promptly
to bring the recorded investment to an amount that the Bank believes is supported by an ability to collect on the collateral. The
circumstances that may impact the Bank’s decision to charge-off all or a portion of a loan include default or non-payment
by the borrower, scheduled foreclosure actions, and/or prioritization of the Bank’s claim in bankruptcy. There may be circumstances
where, due to pending events, the Bank will place a specific allocation of the ALL on a loan for which a partial charge-off has
been previously recognized. This specific allocation may be either charged off or removed depending upon the outcome of the pending
event. Full or partial charge-offs are not recovered until full principal and interest on the loan have been collected, even if
a subsequent appraisal supports a higher value. Loans with partial charge-offs remain in non-accrual status. Both full and partial
charge-offs reduce the recorded investment of the loan and the ALL and are considered to be charge-offs for purposes of all credit
loss metrics and trends, including the historical rolling charge-off rates used in the determination of the ALL.

Activity in the ALL
is presented for the six- and three-months ended June 30, 2012 and June 30, 2011:

Commercial
Real Estate

Acquisition and
Development

Commercial
and Industrial

Residential Mortgage

Consumer

Total

ALL balance at January 1, 2012

$

6,218

$

7,190

$

2,190

$

3,430

$

452

$

19,480

Charge-offs

(2,280

)

(670

)

(9,141

)

(665

)

(347

)

(13,103

)

Recoveries

58

403

332

123

241

1,157

Provision

1,860

(714

)

7,479

569

42

9,236

ALL balance at June 30, 2012

$

5,856

$

6,209

$

860

$

3,457

$

388

$

16,770

ALL balance at January 1, 2011

$

8,658

$

6,345

$

1,345

$

4,211

$

1,579

$

22,138

Charge-offs

(4,530

)

(721

)

(248

)

(802

)

(476

)

(6,777

)

Recoveries

78

271

10

391

285

1,035

Provision

1,906

2,545

1,128

(86

)

(888

)

4,605

ALL balance at June 30, 2011

$

6,112

$

8,440

$

2,235

$

3,714

$

500

$

21,001

22

Commercial
Real
Estate

Acquisition and
Development

Commercial
and
Industrial

Residential Mortgage

Consumer

Total

ALL balance at April 1, 2012

$

6,635

$

5,879

$

929

$

3,377

$

393

$

17,213

Charge-offs

(1,119

)

(424

)

(50

)

(382

)

(174

)

(2,149

)

Recoveries

58

391

2

24

119

594

Provision

282

363

(21

)

438

50

1,112

ALL balance at June 30, 2012

$

5,856

$

6,209

$

860

$

3,457

$

388

$

16,770

ALL balance at April 1, 2011

$

7,948

$

7,131

$

2,071

$

3,851

$

408

$

21,409

Charge-offs

(2,976

)

(326

)

(113

)

(330

)

(244

)

(3,989

)

Recoveries

1

72

8

108

131

320

Provision

1,139

1,563

269

85

205

3,261

ALL balance at June 30, 2011

$

6,112

$

8,440

$

2,235

$

3,714

$

500

$

21,001

The ALL is based on
estimates, and actual losses will vary from current estimates. Management believes that the granularity of the homogeneous pools
and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions,
result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

The following tables
present the average recorded investment in impaired loans by class and related interest income recognized for the periods indicated:

Six months ended
June 30, 2012

Six months ended
June 30, 2011

(in thousands)

Average investment

Interest income
recognized
on an accrual basis

Interest income
recognized
on a cash basis

Average investment

Interest income
recognized
on an accrual basis

Interest income
recognized
on a cash basis

Commercial real estate

Non owner-occupied

$

8,170

$

12

$

0

$

14,366

$

35

$

61

All other CRE

8,110

134

0

6,048

130

50

Acquisition and development

1-4 family residential construction

2,351

46

0

3,064

53

0

All other A&D

22,909

207

0

26,922

290

81

Commercial and industrial

7,022

72

0

10,995

77

0

Residential mortgage

Residential mortgage - term

5,112

67

36

7,254

84

6

Residential mortgage – home equity

1,013

7

3

668

7

3

Consumer

47

0

0

73

0

0

Total

$

54,734

$

545

$

39

$

69,390

$

676

$

201

Three months ended
June 30, 2012

Three months ended
June 30, 2011

(in thousands)

Average investment

Interest income
recognized
on an accrual basis

Interest income
recognized
on a cash basis

Average investment

Interest income
recognized
on an accrual basis

Interest income
recognized
on a cash basis

Commercial real estate

Non owner-occupied

$

7,467

$

6

$

0

$

15,140

$

16

$

61

All other CRE

8,483

54

0

7,345

61

50

Acquisition and development

1-4 family residential construction

2,282

22

0

2,874

26

0

All other A&D

22,759

102

0

26,508

145

81

Commercial and industrial

4,009

38

0

13,927

39

0

Residential mortgage

Residential mortgage - term

5,151

32

21

6,215

41

6

Residential mortgage – home equity

979

3

0

741

3

3

Consumer

60

0

0

33

0

0

Total

$

51,190

$

257

$

21

$

72,783

$

331

$

201

23

In the normal course
of business, the Bank modifies loan terms for various reasons. These reasons may include as a retention strategy to compete in
the current interest rate environment, and to re-amortize or extend a loan term to better match the loan’s payment stream
with the borrower’s cash flows. A modified loan is considered to be a troubled debt restructure (“TDR”) when
the Bank has determined that the borrower is troubled (i.e. experiencing financial difficulties). The Bank evaluates the probability
that the borrower will be in payment default on any of its debt in the foreseeable future without modification. To make this determination,
the Bank performs a global financial review of the borrower and loan guarantors to assess their current ability to meet their financial
obligations.

When the Bank restructures
a loan to a troubled borrower, the loan terms (i.e. interest rate, payment amount, amortization period, and/or maturity date) are
modified in such a way as to enable the borrower to cover the modified debt service payments based on current financials and cash
flow adequacy. If a borrower’s hardship is thought to be temporary, then modified terms are only offered for that time period.
Where possible, the Bank obtains additional collateral and/or secondary payment sources at the time of the restructure in order
to put the Bank in the best possible position if the borrower is not able to meet the modified terms. To date, the Bank has not
forgiven any principal as a restructuring concession. The Bank will not offer modified terms if it believes that modifying the
loan terms will only delay an inevitable permanent default.

All loans designated
as TDRs are considered impaired loans and may be in either accruing or non-accruing status. The Corporation’s policy for
recognizing interest income on impaired loans does not differ from its overall policy for interest recognition. Accordingly, the
accrual of interest is discontinued when principal or interest is delinquent for 90 days or more unless the loan is well-secured
and in the process of collection. If the loan was accruing at the time of the modification, then it continues to be in accruing
status subsequent to the modification. Non-accrual TDRs may return to accruing status when there has been sufficient payment performance
for a period of at least six months. Loans may be removed from TDR status in the calendar year following the modification if the
interest rate at the time of modification was consistent with the interest rate for a loan with comparable credit risk and the
loan has performed according to its modified terms for at least six months.

The volume and type
of TDR activity is considered in the assessment of the local economic trends qualitative factor used in the determination of the
ALL for loans that are evaluated collectively for impairment.

The following table
presents the volume and recorded investment at the time of modification ofTDRs by class and type of modification
that occurred during the periods indicated:

Temporary Rate
Modification

Extension of Maturity

Modification of
Payment and Other Terms

(in thousands)

Number of Contracts

Recorded Investment

Number of Contracts

Recorded Investment

Number of Contracts

Recorded Investment

Six months ended June 30, 2012

Commercial real estate

Non owner-occupied

0

$

0

0

$

0

0

$

0

All other CRE

1

3,110

0

0

0

0

Acquisition and development

1-4 family residential construction

0

0

0

0

0

0

All other A&D

0

0

0

0

0

0

Commercial and industrial

0

0

0

0

0

0

Residential mortgage

Residential mortgage – term

1

513

1

477

1

284

Residential mortgage – home equity

0

0

0

0

0

0

Consumer

0

0

0

0

0

0

Total

2

$

3,623

1

$

477

1

$

284

24

Temporary Rate
Modification

Extension of Maturity

Modification of
Payment and Other Terms

(in thousands)

Number of Contracts

Recorded Investment

Number of Contracts

Recorded Investment

Number of Contracts

Recorded Investment

Three months ended June 30, 2012

Commercial real estate

Non owner-occupied

0

$

0

0

$

0

0

$

0

All other CRE

1

3,110

0

0

0

0

Acquisition and development

1-4 family residential construction

0

0

0

0

0

0

All other A&D

0

0

0

0

0

0

Commercial and industrial

0

0

0

0

0

0

Residential mortgage

Residential mortgage – term

0

0

1

477

1

284

Residential mortgage – home equity

0

0

0

0

0

0

Consumer

0

0

0

0

0

0

Total

1

$

3,110

1

$

477

1

$

284

During the six months
ended June 30, 2012, there were four new TDRs, of which two were new residential mortgage for which there was no impact to the
recorded investment. A $6,796 reduction of the ALL resulted from the movement of the loans being evaluated collectively for impairment
to being evaluated individually for impairment. The remaining two new TDRs during the six months ended June 30, 2012 were impaired
at the time of modification, resulting in no impact to the recorded investment or to the ALL as a result of the modifications.
During the six- and three-month periods ended June 30, 2012, there were no receivables modified as troubled debt restructurings
within the previous 12 months for which there was a payment default during the periods indicated.

Note 8 – Fair
Value of Financial Instruments

The
Corporation complies with the guidance of ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair
value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other
accounting pronouncements. The Corporation also follows the guidance on matters relating to all financial
instruments found in ASC Subtopic 825-10, Financial Instruments – Overall.

Fair value is defined
as the price to sell an asset or to transfer a liability in an orderly transaction between willing market participants as of the
measurement date. Fair value is best determined by values quoted through active trading markets. Active trading markets are characterized
by numerous transactions of similar financial instruments between willing buyers and willing sellers. Because no active trading
market exists for various types of financial instruments, many of the fair values disclosed were derived using present value discounted
cash flows or other valuation techniques described below. As a result, the Corporation’s ability to actually realize these
derived values cannot be assumed.

The
Corporation measures fair values based on the fair value hierarchy established in ASC Paragraph 820-10-35-37. The hierarchy gives
the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and
the lowest priority to unobservable inputs (Level 3 measurements). The three levels of inputs that may be used to measure fair
value under the hierarchy are as follows:

Level 1: Unadjusted quoted
prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities. This level
is the most reliable source of valuation.

25

Level 2: Quoted prices
that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset
or liability. Level 2 inputs include inputs other than quoted prices that are observable for the asset or liability (for example,
interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and
default rates). It also includes inputs that are derived principally from or corroborated by observable market data by correlation
or other means (market-corroborated inputs). Several sources are utilized for valuing these assets, including a contracted valuation
service, Standard & Poor’s (“S&P”) evaluations and pricing services, and other valuation matrices.

Level 3: Prices or valuation
techniques that require inputs that are both significant to the valuation assumptions and not readily observable in the market
(i.e. supported with little or no market activity). Level 3 instruments are valued based on the best available data, some of which
is internally developed, and consider risk premiums that a market participant would require.

The level established
within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The Corporation believes
that its valuation techniques are appropriate and consistent with the techniques used by other market participants. However, the
use of different methodologies and assumptions could result in a different estimate of fair values at the reporting date. The
valuation techniques used by the Corporation to measure, on a recurring and non-recurring basis, the fair value of assets as of
June 30, 2012 are discussed in the paragraphs that follow.

Securities available-for-sale:
The fair value of investments available-for-sale is determined using a market approach. As of June 30, 2012, the U.S. Government
agencies, residential mortgage-backed securities, private label residential mortgage-backed securities, and municipal bonds segments
are classified as Level 2 within the valuation hierarchy. Their fair values were determined based upon market-corroborated inputs
and valuation matrices, which were obtained through third party data service providers or securities brokers through which the
Corporation has historically transacted both purchases and sales of investment securities.

The CDO segment, which
consists of pooled trust preferred securities issued by banks, thrifts and insurance companies, is classified as Level 3 within
the valuation hierarchy. At June 30, 2012, the Corporation owned 18 pooled trust preferred securities with an amortized cost of
$36.6 million and a fair value of $9.3 million. The market for these securities at June 30, 2012 is not active and markets for
similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the
brokered markets in which these securities trade and then by a significant decrease in the volume of trades relative to historical
levels. The new issue market is also inactive, as few CDOs have been issued since 2007. There are currently very few market participants
who are willing to effect transactions in these securities. The market values for these securities or any securities other than
those issued or guaranteed by the U.S. Department of the Treasury (the “Treasury”) are very depressed relative to historical
levels. Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit
markets in general rather than being an indicator of credit problems with a particular issue. Given the conditions in the current
debt markets and the absence of observable transactions in the secondary and new issue markets, management has determined that
(a) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair
value at June 30, 2012, (b) an income valuation approach technique (i.e. present value) that maximizes the use of relevant observable
inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than a market approach,
and (c) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that
significant adjustments were required to determine fair value at the measurement date.

Management utilizes
an independent third party to prepare both the evaluations of other-than-temporary impairment as well as the fair value determinations
for its CDO portfolio. Management does not believe that there were any material differences in the impairment evaluations and pricing
between June 30, 2012 and December 31, 2011.

The approach of the
third party to determine fair value involves several steps, including detailed credit and structural evaluation of each piece of
collateral in each bond, default, recovery and prepayment/amortization probabilities for each piece of collateral in the bond,
and discounted cash flow modeling. The discount rate methodology used by the third party combines a baseline current market yield
for comparable corporate and structured credit products with adjustments based on evaluations of the differences found in structure
and risks associated with actual and projected credit performance of each CDO being valued. Currently, the only active and liquid
trading market that exists is for stand-alone trust preferred securities. Therefore, adjustments to the baseline discount rate
are also made to reflect the additional leverage found in structured instruments.

26

Derivative financial
instruments– The Corporation’s open derivative positions are interest
rate swaps that are classified as Level 3 within the valuation hierarchy. Open derivative positions are valued using externally
developed pricing models based on observable market inputs provided by a third party and validated by management. The Corporation
has considered counterparty credit risk in the valuation of its interest rate swap assets.

Impaired loans
– Loans included in the table below are those that are considered impaired with a specific allocation or with a partial charge-off,
based upon the guidance of the loan impairment subsection of the Receivables Topic, ASC Section 310-10-35, under which the
Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value consists of the
loan balance less its valuation allowance and is generally determined based on independent third-party appraisals of the collateral
or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values based upon the lowest
level of input that is significant to the fair value measurements.

Other real estate
owned – Other real estate owned included in the table below are considered impaired with specific write-downs. Fair
value of other real estate owned is based on independent third-party appraisals of the properties. These values were determined
based on the sales prices of similar properties in the approximate geographic area. These assets are included as Level 3 fair values
based upon the lowest level of input that is significant to the fair value measurements.

For Level 3 assets
and liabilities measured at fair value on a recurring and non-recurring basis as of June 30, 2012, the significant unobservable
inputs used in the fair value measurements were as follows:

Fair
Value at June 30, 2012

Valuation
Technique

Significant
Unobservable Inputs

Significant
Unobservable Input Value

Recurring:

Investment Securities – available
for sale

$

9,339

Discounted
Cash Flow

Discount
Rate

Swap+19%;
Range of Libor+ 9% to 20%

Cash Flow Hedge

$

(955

)

Discounted Cash Flow

Reuters Third Party Market
Quote

99.90

%

Non-recurring:

Impaired Loans

$

18,023

Market Comparable Properties

Marketability Discount

10% to 30%

(1)

(1)

Range would include discounts taken since appraisal and estimated values

For assets measured
at fair value on a recurring and non-recurring basis, the fair value measurements by level within the fair value hierarchy used
at June 30, 2012 and December 31, 2011 are as follows:

Fair Value Measurements at June 30, 2012 Using(In Thousands)

Description

Assets Measured at Fair Value 06/30/2012

Quoted Prices in Active Markets for Identical Assets (Level 1)

Significant Other Observable Inputs (Level 2)

Significant Unobservable Inputs (Level 3)

Recurring:

Investment securities available-for-sale:

U.S. government agencies

$

25,497

$

25,497

Residential mortgage-backed agencies

$

86,084

$

86,084

Commercial mortgage-backed agencies

$

49,303

$

49,303

Collateralized mortgage obligations

$

601

$

601

Obligations of states and political subdivisions

$

56,420

$

56,420

Collateralized debt obligations

$

9,339

$

9,339

Financial Derivative

$

(955

)

$

(955

)

Non-recurring:

Impaired loans

$

18,023

$

18,023

Other real estate owned

$

0

$

0

27

Fair Value Measurements at December 31, 2011 Using(In Thousands)

Description

Assets Measured at Fair Value 12/31/2011

Quoted Prices in Active Markets for Identical Assets (Level 1)

Significant Other Observable Inputs (Level 2)

Significant Unobservable Inputs (Level 3)

Recurring:

Investment securities available-for-sale:

U.S. government agencies

$

25,580

$

25,580

Residential mortgage-backed agencies

$

95,691

$

95,691

Commercial mortgage-backed agencies

$

44,932

$

44,932

Collateralized mortgage obligations

$

557

$

557

Obligations of states and political subdivisions

$

68,816

$

68,816

Collateralized debt obligations

$

9,447

$

9,447

Financial Derivative

$

(1,034

)

$

(1,034

)

Non-recurring:

Impaired loans

$

30,320

$

30,320

Other real estate owned

$

3,449

$

3,449

There were no transfers
of assets between Level 1 and Level 2 of the fair value hierarchy for the six months ended June 30, 2012 or June 30, 2011.

The following tables
show a reconciliation of the beginning and ending balances for fair valued assets measured on a recurring basis using Level 3 significant
unobservable inputs for the six-months ended June 30, 2012 and the year ended December 31, 2011:

The amount of total gains or losses for the period included in earnings attributable to the change in realized/unrealized gains or losses related to assets still held at the reporting date

$

0

$

0

Gains and losses (realized
and unrealized) included in earnings for the periods above are reported in the Consolidated Statements of Operations in Other Operating
Income.

The fair values disclosed
may vary significantly between institutions based on the estimates and assumptions used in the various valuation
methodologies. The derived fair values are subjective in nature and involve uncertainties and significant judgment. Therefore,
they cannot be determined with precision. Changes in the assumptions could significantly impact the derived estimates of fair value.
Disclosure of non-financial assets such as buildings as well as certain financial instruments such as leases is not required. Accordingly,
the aggregate fair values presented do not represent the underlying value of the Corporation.

The following methods
and assumptions were used by the Corporation to estimate its fair value disclosures for financial instruments:

Cash and due
from banks: The carrying amounts as reported in the statement of financial condition for cash and due from banks approximate
their fair values.

Securities
held to maturity:Investments in debt securities classified as held to maturity are measured subsequently
at amortized cost in the statement of financial position. These assets are included as Level 3 fair
values based upon the lowest level of input that is significant to the fair value measurements.

Restricted Investment
in Bank stock: The carrying value of stock issued by the FHLB of Atlanta, ACBB and CBB approximates fair value based on
the redemption provisions of the stock.

Loans (excluding
impaired loans with specific loss allowances): For variable-rate loans that re-price frequently or “in one year or
less”, and with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed-rate
loans that do not re-price frequently are estimated using a discounted cash flow calculation that applies current market interest
rates being offered on the various loan products.

Deposits:
The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and certain types of money market
accounts, etc.) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts).
Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest
rates currently being offered on the various certificates of deposit to the cash flow stream.

30

Borrowed
funds: The fair value of the Bank’s FHLB borrowings and junior subordinated debt is calculated based on the discounted
value of contractual cash flows, using rates currently existing for borrowings with similar remaining
maturities. The carrying amounts of federal funds purchased and securities sold under agreements to repurchase approximate their
fair values.

Off-Balance-Sheet
Financial Instruments: In the normal course of business, the Bank makes commitments to extend credit and issues standby
letters of credit. The Bank expects most of these commitments to expire without being drawn upon; therefore, the commitment amounts
do not necessarily represent future cash requirements. Due to the uncertainty of cash flows and difficulty in the predicting the
timing of such cash flows, fair values were not estimated for these instruments.

The following tables
present fair value information about financial instruments, whether or not recognized in the statement
of financial condition, for which it is practicable to estimate that value. The actual carrying amounts and estimated fair
values of the Corporation’s financial instruments that are included in the statement of financial condition
are as follows:

June 30, 2012

Fair Value Measurements

(in thousands)

Carrying Amount

Fair Value

Quoted Prices in Active Markets for Identical Assets (Level 1)

Significant Other Observable Inputs (Level 2)

Significant Unobservable Inputs (Level 3)

Financial Assets:

Cash and due from banks

$

53,305

$

53,305

$

53,305

Interest bearing deposits in banks

13,634

13,634

13,634

Investment securities - AFS

227,244

227,244

$

217,905

$

9,339

Investment securities - HTM

4,040

4,040

4,040

Restricted Bank stock

9,679

9,679

9,679

Loans, net

891,139

888,695

888,695

Accrued interest receivable

4,502

4,502

4,502

Financial Liabilities:

Deposits – non-maturity

594,009

594,009

594,009

Deposits – time deposits

402,331

406,278

406,278

Short-term borrowed funds

28,902

28,902

28,902

Long-term borrowed funds

206,515

217,819

217,819

Accrued interest payable

4,379

4,379

4,379

Financial derivative

955

955

955

Off-balance-sheet financial instruments

0

0

0

Loans are measured using a discounted cash
flow method. The significant unobservable inputs used in the Level 3 fair value measurements of the Corporation’s loans included
in the table above are calculated based on the Corporation’s internal new volume rate.

31

December 31, 2011

(in thousands)

Carrying
Amount

Fair Value

Financial Assets:

Cash and due from banks

$

52,049

$

52,049

Interest bearing deposits in banks

13,058

13,058

Investment securities-AFS

245,023

245,023

Restricted Bank stock

10,726

10,726

Loans, net

919,214

918,156

Accrued interest receivable

5,058

5,058

Financial Liabilities:

Deposits

1,027,784

994,165

Borrowed funds

243,912

251,850

Accrued interest payable

3,512

3,512

Financial derivative

1,034

1,034

Off balance sheet financial instruments

0

0

Note 9 – Accumulated Other Comprehensive Loss

The following table
presents the changes in each component of accumulated other comprehensive loss for the 12 months ended December 31, 2011 and the
three months ended March 31, 2012 and June 30, 2012:

First United Corporation
is the parent company to three statutory trust subsidiaries - First United Statutory Trust I and First United Statutory Trust II,
both of which are Connecticut statutory trusts (“Trust I” and “Trust II”, respectively), and First United
Statutory Trust III, a Delaware statutory trust (“Trust III” and, together with Trust I and Trust II, the “Trusts”).
The Trusts were formed for the purposes of selling preferred securities to investors and using the proceeds to purchase junior
subordinated debentures from First United Corporation (“TPS Debentures”) that would qualify as regulatory capital.

32

In March 2004, Trust
I and Trust II issued preferred securities with an aggregate liquidation amount of $30.0 million to third-party investors and
issued common equity with an aggregate liquidation amount of $.9 million to First United Corporation. Trust I and Trust II used
the proceeds of these offerings to purchase an equal amount of TPS Debentures, as follows:

$20.6 million—floating rate payable quarterly
based on three-month LIBOR plus 275 basis points (3.22% at June 30, 2012), maturing in 2034, became
redeemable five years after issuance at First United Corporation’s option.

$10.3 million—floating rate payable quarterly
based on three-month LIBOR plus 275 basis points (3.22% at June 30, 2012) maturing in 2034, became redeemable
five years after issuance at First United Corporation’s option.

In December 2004, First
United Corporation issued $5.0 million of junior subordinated debentures to third-party investors that were not tied to
preferred securities. The debentures had a fixed rate of 5.88% for the first five years, payable quarterly,
and converted to a floating rate in March 2010 based on the three month LIBOR plus 185 basis points (2.32% at June 30, 2012). The
debentures mature in 2015, but became redeemable five years after issuance at First United Corporation’s option.

In December 2009, Trust
III issued 9.875% fixed-rate preferred securities with an aggregate liquidation amount of approximately $7.0 million to private
investors and issued common securities to First United Corporation with an aggregate liquidation
amount of approximately $.2 million. Trust III used the proceeds of the offering to purchase approximately $7.2 million of 9.875%
fixed-rate TPS Debentures. Interest on these TPS Debentures are payable quarterly, and the TPS
Debentures mature in 2040 but are redeemable five years after issuance at First United Corporation’s
option.

In January 2010, Trust
III issued an additional $3.5 million of 9.875% fixed-rate preferred securities to private investors and issued common securities
to First United Corporation with an aggregate liquidation amount of $.1 million. Trust III used
the proceeds of the offering to purchase $3.6 million of 9.875% fixed-rate TPS Debentures. Interest
on these TPS Debentures are payable quarterly, and the TPS Debentures mature in 2040 but are
redeemable five years after issuance at First United Corporation’s option.

The TPS Debentures
issued to each of the Trusts represent the sole assets of that Trust, and payments of the TPS Debentures by First
United Corporation are the only sources of cash flow for the Trust. First United Corporation
has the right, without triggering a default, to defer interest on all of the TPS Debentures for up to 20 quarterly periods, in
which case distributions on the preferred securities will also be deferred. Should this occur, the Corporation
may not pay dividends or distributions on, or repurchase, redeem or acquire any shares of its capital stock.

At
the request of the Federal Reserve Bank of Richmond (the “FRBR”), First United Corporation elected to defer quarterly
interest payments under its TPS Debentures beginning with the payment that was due in March 2011. As of June 30, 2012, this deferral
election remained in effect. Cumulative deferred interest on all TPS Debentures was approximately $3.3 million, which must be paid
in full when First United Corporation terminates the deferral of interest payments. Management cannot predict when the deferral
will be terminated. First United Corporation’s ability to resume quarterly interest payments will depend primarily on our
earnings in future periods.

Interest payments on
the $5.0 million junior subordinated debentures that were issued outside of trust preferred securities offerings cannot be, and
have not been, deferred.

The
terms of First United Corporation’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred
Stock”) call for the payment, if declared by the Board of Directors of First United Corporation,
of cash dividends on February 15th, May 15th, August 15th and November 15th of each
year. On November 15, 2010, at the request of the FRBR, the board of directors of First United Corporation voted to suspend quarterly
cash dividends on the Series A Preferred Stock beginning with the November 15, 2010 dividend payment date. Dividends of $.4 million
per dividend period continue to accrue, and First United Corporation will be required to pay all accrued and unpaid dividends if
and when the board of directors declares the next quarterly cash dividend. Cumulative deferred dividends on the Series A Preferred
Stock was approximately $2.7 million as of June 30, 2012. Management cannot predict whether or when First United Corporation
will resume the payment of quarterly dividends on the Series A Preferred Stock. First United Corporation’s ability to pay
cash dividends in the future will depend primarily on our earnings in future periods.

In December 2010, in
connection with the above-mentioned deferral of dividends on the Series A Preferred Stock, the board of directors of First United
Corporation voted to suspend the payment of quarterly cash dividends on the common stock starting in 2011.

33

Note 11 – Borrowed
Funds

The following is a summary of short-term borrowings with original
maturities of less than one year:

(Dollars in thousands)

Six Months Ended June 30, 2012

Year Ended December 31, 2011

Securities sold under agreements to repurchase:

Outstanding at end of period

$

28,902

$

36,868

Weighted average interest rate at end of period

0.68

%

0.64

%

Maximum amount outstanding as of any month end

$

36,627

$

51,403

Average amount outstanding

$

35,347

$

41,728

Approximate weighted average rate during the period

0.55

%

0.56

%

At June 30, 2012, the repurchase agreements
were secured by $39.4 million in available-for-sale investment securities.

The following is a summary of long-term
borrowings with original maturities exceeding one year:

(In thousands)

June 30, 2012

December 31, 2011

FHLB advances, bearing fixed interest at rates ranging from 1.00% to 4.55% at June 30, 2012

At June 30, 2012, the long-term FHLB advances
were secured by $148.7 million in loans and $20.3 million in investment securities.

The contractual maturities of all long-term
borrowings are as follows:

June 30, 2012

December 31,
2011

Fixed Rate

Floating Rate

Total

Total

Due in 2012

$

23,750

$

0

$

23,750

$

44,250

Due in 2013

0

0

0

0

Due in 2014

0

0

0

0

Due in 2015

30,000

5,000

35,000

35,000

Due in 2016

0

0

0

0

Due in 2017

0

0

0

0

Thereafter

116,836

30,929

147,765

127,794

Total long-term debt

$

170,586

$

35,929

$

206,515

$

207,044

34

Note 12 - Pension and SERP Plans

The following table
presents the components of the net periodic pension plan cost for First United Corporation’s Defined Benefit Pension Plan
and the Bank’s Supplemental Executive Retirement Plan (“SERP”) for the periods indicated:

Pension

For the six months
ended June 30,

For the three months
ended June 30,

(In thousands)

2012

2011

2012

2011

Service cost

$

0

$

0

$

0

$

0

Interest cost

691

660

340

330

Expected return on assets

(1,107

)

(1,120

)

(554

)

(560

)

Amortization of transition asset

(20

)

(20

)

(10

)

(10

)

Recognized net actuarial loss

190

200

90

100

Amortization of prior service cost

6

4

3

2

Net pension credit included in employee benefits

$

(240

)

$

(276

)

$

(131

)

$

(138

)

SERP

For the six months
ended June 30,

For the three months
ended June 30,

(In thousands)

2012

2011

2012

2011

Service cost

$

60

$

80

$

30

$

40

Interest cost

126

114

63

57

Amortization of recognized loss

6

0

3

0

Amortization of prior service cost

62

63

31

31

Net pension expense included in employee benefits

$

254

$

257

$

127

$

128

Effective April 30,
2010, the Pension Plan was amended, resulting in a “soft freeze”. The effects of the amendment were to prohibit new
entrants into the plan and to cease crediting additional years of service after that date.

The Corporation does
not intend to contribute to the Pension Plan in 2012 based upon its fully funded status and an evaluation of the future benefits
provided under the Pension Plan. The Corporation expects to fund the annual projected benefit payments for the SERP from operations.

Note 13 - Equity Compensation Plan Information

At the 2007 Annual
Meeting of Shareholders, First United Corporation’s shareholders approved the First United Corporation Omnibus Equity Compensation
Plan (the “Omnibus Plan”), which authorizes the issuance of up to 185,000 shares of common stock pursuant to the grant
of stock options, stock appreciation rights, stock awards, stock units, performance units, dividend equivalents, and other stock-based
awards to employees or directors.

On June 18, 2008,
the Board of Directors of First United Corporation adopted a Long-Term Incentive Program (the “LTIP”). This program
was adopted as a sub-plan of the Omnibus Plan to reward participants for increasing shareholder value, align executive interests
with those of shareholders, and serve as a retention tool for key executives. Under the LTIP, participants are granted shares
of restricted common stock of First United Corporation. The amount of an award is based on a specified percentage of the participant’s
salary as of the date of grant. These shares will vest if the Corporation meets or exceeds certain performance thresholds. There
were no grants of restricted stock outstanding at June 30, 2012.

35

The Corporation complies
with the provisions of ASC Topic 718, Compensation-Stock Compensation, in measuring and disclosing stock compensation
cost. The measurement objective in ASC Paragraph 718-10-30-6 requires public companies to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant date fair value of the award. The cost is recognized
in expense over the period in which an employee is required to provide service in exchange for the award (the vesting period).
The performance-related shares granted in connection with the LTIP are expensed ratably from the date that the likelihood of meeting
the performance measures is probable through the end of a three year vesting period.

The American Recovery
and Reinvestment Act of 2009 (the “Recovery Act”) imposes restrictions on the type and timing of bonuses and incentive
compensation that may be accrued for or paid to certain employees of institutions that participated in Treasury’s Capital
Purchase Program. The Recovery Act generally limits bonuses and incentive compensation to grants of long-term restricted stock
that, among other requirements, cannot fully vest until the Capital Purchase Program assistance is repaid.

Stock-based awards
were made to non-employee directors in May 2012 pursuant to First United Corporation’s director compensation policy. Five
thousand dollars of each director’s annual retainer is paid in shares of stock, with the remainder paid in cash. Beginning
in 2011, each non-employee director was given the option to receive the remainder of his or her retainer, or any portion thereof,
in shares of stock. A total of 16,526 fully-vested shares of common stock were issued to directors in 2012, which had a fair market
value of $5.14 per share. Director stock compensation expense was $31,217 for the six months ended June 30, 2012 and $52,300 for
the six months ended June 30, 2011.

Note 14 – Letters of Credit and Off Balance Sheet
Liabilities

The Corporation does
not issue any guarantees that would require liability recognition or disclosure other than the standby letters of credit issued
by the Bank. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a
customer to a third party. Generally, the Bank’s letters of credit are issued with expiration dates within one year.
The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to
customers. The Bank generally holds collateral and/or personal guarantees supporting these commitments. The Bank
had $1.7 million of outstanding standby letters of credit at June 30, 2012 and $1.5 million at December 31, 2011. Management believes
that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover
the potential amount of future payment required by the letters of credit. Management does not believe that the amount of
the liability associated with guarantees under standby letters of credit outstanding at June 30, 2012 and December 31, 2011 is
material.

Note 15 – Derivative Financial Instruments

As a part of managing
interest rate risk, the Bank entered into interest rate swap agreements to modify the re-pricing characteristics of certain interest-bearing
liabilities. The Corporation has designated these interest rate swap agreements as cash flow hedges under the guidance of ASC
Subtopic 815-30, Derivatives and Hedging – Cash Flow Hedges. Cash flow hedges have the effective portion of changes
in the fair value of the derivative, net of taxes, recorded in net accumulated other comprehensive income.

In July 2009, the
Bank entered into three interest rate swap contracts totaling $20.0 million notional amount, hedging future cash flows associated
with floating rate trust preferred debt. As of June 30, 2012 swap contracts totaling $15.0 million notional amount remained, as
the three-year $5.0 million contract matured on June 15, 2012. The fair value of the interest rate swap contracts was ($955) thousand
at June 30, 2012 and ($1.0) million at December 31, 2011 and was reported in Other Liabilities on the Consolidated Statements
of Financial Condition. Cash in the amount of $1.4 million was posted as collateral as of June 30, 2012.

For the six months
ended June 30, 2012, the Corporation recorded an increase in the value of the derivatives of $79 thousand and the related deferred
tax benefit of $32 thousand in net accumulated other comprehensive loss to reflect the effective portion of cash flow hedges.
ASC Subtopic 815-30 requires this amount to be reclassified to earnings if the hedge becomes ineffective or is terminated. There
was no hedge ineffectiveness recorded for the six months ending June 30, 2012. The Corporation does not expect any losses relating
to these hedges to be reclassified into earnings within the next 12 months.

Interest rate swap
agreements are entered into with counterparties that meet established credit standards and the Corporation believes that the credit
risk inherent in these contracts is not significant as of June 30, 2012.

36

The table below discloses
the impact of derivative financial instruments on the Corporation’s Consolidated Financial Statements for the six- and three-months
ended June 30, 2012 and 2011.

Derivative in Cash Flow Hedging Relationships

(In thousands)

Amount of gain or (loss) recognized in
OCI on derivative (effective portion)

Amount of gain or (loss) reclassified
from accumulated OCI into income (effective portion) (a)

Amount of gain or (loss) recognized in
income on derivative (ineffective portion and amount excluded from effectiveness
testing) (b)

Interest rate contracts:

Six months ended:

June 30, 2012

$

79

$

0

$

0

June 30, 2011

$

(84

)

0

0

Three months ended:

June 30, 2012

$

33

0

0

June 30, 2011

$

(253

)

$

0

$

0

Notes:

(a)

Reported as interest expense

(b)

Reported as other income

Note 16 – Variable Interest Entities (VIE)

As noted in Note 10,
First United Corporation created the Trusts for the purposes of raising regulatory capital through the sale of mandatorily redeemable
preferred capital securities to third party investors and common equity interests to First United Corporation. The Trusts are
considered Variable Interest Entities (“VIEs”), but are not consolidated because First United Corporation is not the
primary beneficiary of the Trusts. At June 30, 2012, the Corporation reported all of the $41.7 million of TPS Debentures issued
in connection with these offerings as long-term borrowings (along with the $5.0 million of stand-alone junior subordinated debentures),
and it reported its $1.3 million equity interest in the Trusts as “Other Assets”.

In
November 2009, the Bank became a 99.99% limited partner in Liberty Mews Limited Partnership (the “Partnership”);
a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett
County, Maryland. The Partnership was financed with a total of $10.6 million of funding, including
a $6.1 million equity contribution from the Bank as the limited partner. The Partnership used the proceeds from these sources
to purchase the land and construct a 36-unit low income housing rental complex at a total cost of $10.6 million. The total assets
of the Partnership were approximately $10.2 million at June 30, 2012 and $10.9 million at December 31, 2011.

As of December 31,
2011, the Bank had made contributions to the Partnership totaling $6.1 million. The project was completed in June 2011, and the
Bank is entitled to $8.6 million in federal investment tax credits over a 10-year period as long as certain qualifying hurdles
are maintained. The Bank will also receive the benefit of tax operating losses from the Partnership to the extent of its capital
contribution. The investment in the Partnership assists the Bank in achieving its community reinvestment initiatives.

Because the Partnership
is considered to be a VIE, management performed an analysis to determine whether its involvement with the Partnership would lead
it to determine that it must consolidate the Partnership. In performing its analysis, management evaluated the risks creating
the variability in the Partnership and identified which activities most significantly impact the VIE’s economic performance.
Finally, it examined each of the variable interest holders to determine which, if any, of the holders was the primary beneficiary
based on their power to direct the most significant activities and their obligation to absorb potentially significant losses of
the Partnership.

37

The Bank, as a limited
partner, generally has no voting rights. The Bank is not in any way involved in the daily management of the Partnership and has
no other rights that provide it with the power to direct the activities that most significantly impact the Partnership’s
economic performance, which are to develop and operate the housing project in such a manner that complies with specific tax credit
guidelines. As a limited partner, there is no recourse to the Bank by the creditors of the Partnership. The tax credits that result
from the Bank’s investment in the Partnership are generally subject to recapture should the partnership fail to comply with
the applicable government regulations. The Bank has not provided any financial or other support to the Partnership beyond its
required capital contributions and does not anticipate providing such support in the future. Management currently believes that
no material losses are probable as a result of the Bank’s investment in the Partnership.

On the basis of management’s
analysis, the general partner is deemed to be the primary beneficiary of the Partnership. Because the Bank is not the primary
beneficiary, the Partnership has not been included in the Corporation’s consolidated financial statements.

At June 30, 2012 and
December 31, 2011, the Corporation included its total investment in the Partnership in “Other Assets” in its Consolidated
Statements of Financial Condition. As of June 30, 2012, the Corporation’s commitment in the Partnership is fully funded.
The following table presents details of the Bank’s involvement with the Partnership at the dates indicated:

(In thousands)

June 30, 2012

December 31, 2011

Investment in LIHTC Partnership

Carrying amount on Balance Sheet of:

Investment (Other Assets)

$

5,736

$

5,980

Maximum exposure to loss

5,736

5,980

Note 17 – Adoption of New Accounting Standards and
Effects of New Accounting Pronouncements

There were no new
accounting pronouncements affecting the Corporation during the period that were not previously disclosed.

38

Item 2. Management's Discussion
and Analysis of Financial Condition and Results of Operations

INTRODUCTION

The following discussion
and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results
of operations of the Corporation and its consolidated subsidiaries for the periods indicated. This discussion and analysis should
be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part
I of this report. Unless the context clearly suggests otherwise, references in this report to “us”, “we”,
“our”, and “the Corporation” are to First United Corporation and its consolidated subsidiaries.

FORWARD-LOOKING STATEMENTS

This report may contain
forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Readers of this report
should be aware of the speculative nature of “forward-looking statements.” Statements that are not historical in nature,
including those that include the words “anticipate”, “estimate”, “should”, “expect”,
“believe”, “intend”, and similar expressions, are based on current expectations, estimates and projections
about, among other things, the industry and the markets in which we operate, and they are not guarantees of future performance.
Whether actual results will conform to expectations and predictions is subject to known and unknown risks and uncertainties, including
risks and uncertainties discussed in this report; general economic, market, or business conditions; changes in interest rates,
deposit flow, the cost of funds, and demand for loan products and financial services; changes in our competitive position or competitive
actions by other companies; changes in the quality or composition of our loan and investment portfolios; our ability to manage
growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond
our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements,
and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the
expected consequences on our business or operations. These and other risks are discussed in detail in the periodic reports that
First United Corporation files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of
this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions
of any forward-looking statements we make to reflect new information, future events or otherwise.

FIRST UNITED CORPORATION

First United Corporation
is a Maryland corporation chartered in 1985 and a financial holding company registered under the federal Bank Holding Company
Act of 1956, as amended. First United Corporation’s primary business is serving as the parent company of First United Bank
& Trust, a Maryland trust company (the “Bank”), First United Statutory Trust I (“Trust I”) and First
United Statutory Trust II (“Trust II”), both Connecticut statutory business trusts, and First United Statutory Trust
III, a Delaware statutory business trust (“Trust III” and together with Trust I and Trust II, the “Trusts”).
The Trusts were formed for the purpose of selling trust preferred securities that qualified as Tier 1 capital. First United Corporation
is also the parent company of First United Insurance Group, LLC, a Maryland limited liability company (the “Insurance Agency”)
that, through the close of business on December 31, 2011, operated as a full service insurance provider. Effective on January
1, 2012, the Insurance Agency sold substantially all of its assets, net of cash, to a third-party and is no longer an active subsidiary.
The Bank has three wholly-owned subsidiaries: OakFirst Loan Center, Inc., a West Virginia finance company; OakFirst Loan Center,
LLC, a Maryland finance company (collectively, the “OakFirst Loan Centers”), and First OREO Trust, a Maryland statutory
trust formed for the purposes of servicing and disposing of the real estate that the Bank acquires through foreclosure or by deed
in lieu of foreclosure. The Bank owns a majority interest in Cumberland Liquidation Trust, a Maryland statutory trust formed for
the purposes of servicing and disposing of real estate that secured a loan made by another bank and in which the Bank held a participation
interest. The Bank also owns 99.9% of the limited partnership interests in Liberty Mews Limited Partnership; a Maryland limited
partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland.
The Bank provides a complete range of retail and commercial banking services to a customer base serviced by a network of 28 offices
and 29 automated teller machines.

At June 30, 2012,
the Corporation had total assets of approximately $1.35 billion, net loans of $891.1 million, and deposits of approximately $996.3
million. Shareholders’ equity at June 30, 2012 was approximately $95.1 million.

The Corporation maintains
an Internet site at www.mybank4.com on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports
on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports
are electronically filed with, or furnished to, the SEC.

39

ESTIMATES AND CRITICAL ACCOUNTING POLICIES

This discussion and
analysis of our financial condition and results of operations is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation
of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent liabilities. (See Note 1 of the Notes to Consolidated
Financial Statements included in Item 8 of Part II of First United Corporation’s Annual Report on Form 10-K for the year
ended December 31, 2011.) On an on-going basis, management evaluates estimates, including those related to loan losses and intangible
assets, other-than–temporary impairment (“OTTI”) of investment securities, income taxes, fair value of investments
and pension plan assumptions. Management bases its estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant
judgments and estimates used in the preparation of the consolidated financial statements.

Allowance for Loan Losses

One of our most important
accounting policies is that related to the monitoring of the loan portfolio. A variety of estimates impact the
carrying value of the loan portfolio, including the calculation of the allowance for loan losses (the “ALL”), the
valuation of underlying collateral, the timing of loan charge-offs and the placement of loans on non-accrual status. The allowance
is established and maintained at a level that management believes is adequate to cover losses resulting from the inability of
borrowers to make required payment on loans. Estimates for loan losses are arrived at by analyzing risks associated with specific
loans and the loan portfolio, current and historical trends in delinquencies and charge-offs, and changes in the size and composition
of the loan portfolio. The analysis also requires consideration of the economic climate and direction, changes in lending rates,
political conditions, legislation impacting the banking industry and economic conditions specific to Western Maryland and Northeastern
West Virginia. Because the calculation of the ALL relies on management’s estimates and judgments relating to inherently
uncertain events, actual results may differ from management’s estimates.

Goodwill and Other Intangible Assets

Financial Accounting
Standards Board Accounting Standards Codification (“ASC”) Topic 350, Intangibles - Goodwill and Other, establishes
standards for the amortization of acquired intangible assets and impairment assessment of goodwill.
The $11 million in recorded goodwill is primarily related to the acquisition of Huntington National Bank branches that occurred
in 2003 and is not subject to periodic amortization.

Goodwill arising from
business combinations represents the value attributable to unidentifiable intangible elements in the business acquired. Goodwill
is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that
the asset might be impaired. Impairment testing requires that the fair value of each of the Corporation’s reporting units
be compared to the carrying amount of its net assets, including goodwill. If the estimated current fair value of the reporting
unit exceeds its carrying value, no additional testing is required and an impairment loss is not recorded. Otherwise, additional
testing is performed, and to the extent such additional testing results in a conclusion that the carrying value of goodwill exceeds
its implied fair value, an impairment loss is recognized.

Our goodwill relates
to value inherent in the banking business and the value is dependent upon our ability to provide quality, cost effective services
in a highly competitive local market. This ability relies upon continuing investments in processing systems, the development
of value-added service features and the ease of use of our services. As such, goodwill value is supported ultimately by
revenue that is driven by the volume of business transacted. A decline in earnings as a result of a lack of growth or the
inability to deliver cost effective services over sustained periods can lead to impairment of goodwill, which could adversely
impact earnings in future periods. ASC Topic 350 requires an annual evaluation of goodwill for impairment. The determination
of whether or not these assets are impaired involves significant judgments and estimates.

40

Accounting for Income Taxes

The Corporation accounts
for income taxes by recording deferred income taxes that reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises
significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities.
The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws.

A valuation allowance
is recognized to reduce any deferred tax assets when, based upon available information, management concludes that it is more-likely-than-not
that all, or any portion, of the deferred tax asset will not be realized. Assessing the need for, and amount of, a valuation
allowance for deferred tax assets requires significant judgment and analysis of evidence regarding realization of the deferred
tax assets. In most cases, the realization of deferred tax assets is dependent upon the recognition of deferred tax liabilities
and generating a sufficient level of taxable income in future periods, which can be difficult to predict. Our largest deferred
tax assets involve differences related to ALL and unrealized losses on investment securities. Given the nature of our deferred
tax assets, management determined no valuation allowances were needed at June 30, 2012 except for a state valuation allowance
for certain state deferred tax assets associated with our Parent Company.

Management expects
that the Corporation’s adherence to the required accounting guidance may result in increased volatility in quarterly and
annual effective income tax rates because of changes in judgment or measurement including changes in actual and forecasted income
before taxes, tax laws and regulations, and tax planning strategies.

Other-Than-Temporary Impairment of Investment Securities

Securities available-for-sale:
Securities available-for-sale are stated at fair value, with the unrealized gains and losses, net of tax, reported in the
accumulated other comprehensive income/(loss) component in shareholders’ equity.

The amortized cost
of debt securities classified as available-for-sale is adjusted for amortization of premiums to the first call date, if applicable,
or to maturity, and for accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life
of the security. Such amortization and accretion, plus interest and dividends, are included in interest income from investments.
Gains and losses on the sale of securities are recorded using the specific identification method.

Management
systematically evaluates securities for impairment on a quarterly basis. Based upon application of accounting guidance for subsequent
measurement in ASC Topic 320 (Section 320-10-35), management assesses whether (a) it has the intent
to sell a security being evaluated and (b) it is more likely than not that the Corporation will be required to sell the security
prior to its anticipated recovery. If neither applies, then declines in the fair values of securities below their cost
that are considered other-than-temporary declines are split into two components. The first is the loss attributable to declining
credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination
is made. The second component consists of all other losses, which are recognized in other comprehensive loss. In estimating OTTI
losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) adverse
conditions specifically related to the security, an industry, or a geographic area, (3) the historic and implied volatility of
the fair value of the security, (4) changes in the rating of the security by a rating agency, (5) recoveries or additional declines
in fair value subsequent to the balance sheet date, (6) failure of the issuer of the security to make scheduled interest or principal
payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able to make payments that
increase in the future. Management also monitors cash flow projections for securities that are
considered beneficial interests under the guidance of ASC Subtopic 325-40, Investments – Other – Beneficial Interests
in Securitized Financial Assets, (ASC Section 325-40-35).
This process is described more fully in the Investment Securities section of the Consolidated Balance Sheet Review.

Fair Value of Investments

We
have determined the fair value of our investment securities in accordance with the requirements of ASC Topic 820, Fair Value
Measurements and Disclosures, which defines fair value, establishes a framework for measuring
fair value and expands disclosures about fair value measurements required under other accounting pronouncements. The Corporation
measures the fair market values of its investments based on the fair value hierarchy established in Topic 820. The determination
of fair value of investments and other assets is discussed further in Note 8 to the consolidated financial statements presented
elsewhere in this report.

41

Pension Plan Assumptions

Our pension plan costs
are calculated using actuarial concepts, as discussed within the requirements of ASC Topic 715, Compensation – Retirement
Benefits. Pension expense and the determination of our projected pension liability are based upon two critical assumptions:
the discount rate and the expected return on plan assets. We evaluate each of these critical assumptions annually. Other assumptions
impact the determination of pension expense and the projected liability including the primary employee demographics, such as retirement
patterns, employee turnover, mortality rates, and estimated employer compensation increases. These factors, along with the critical
assumptions, are carefully reviewed by management each year in consultation with our pension plan consultants and actuaries. Further
information about our pension plan assumptions, the plan’s funded status, and other plan information is included in Note
12 to the consolidated financial statements presented elsewhere in this report.

Other than as discussed
above, management does not believe that any material changes in our critical accounting policies have occurred since December
31, 2011.

SELECTED FINANCIAL DATA

The following table sets forth certain
selected financial data for the six months ended June 30, 2012 and 2011 and is qualified in its entirety by the detailed information
and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.

As of or For the six months ended June 30,

2012

2011

Per Share Data

Basic net (loss)/income per common share

$

(.30

)

$

.21

Diluted net (loss)/income per common share

$

(.30

)

$

.21

Book Value

$

10.54

$

11.04

Significant Ratios

Return on Average Assets (a)

(.15

)%

.28

%

Return on Average Equity (a)

(2.12

)%

4.34

%

Average Equity to Average Assets

7.01

%

6.37

%

Note: (a) Annualized

RESULTS OF OPERATIONS

Overview

Consolidated net loss
attributable to common shareholders was $1.9 million for the first six months of 2012, compared to net income available to common
shareholders of $1.3 million for the same period of 2011. Basic and diluted net loss per common share for the first six months
of 2012 was $.30, compared to net income per common share of $.21 for the same period of 2011. The change in earnings, from net
income for the first six months of 2011 to a net loss for the first six months of 2012, resulted primarily from increased provision
for loan losses of $4.6 million. The increase in provision expense was partially offset by an increase in other operating income
due to a one-time, tax free death benefit of approximately $.7 million received under a policy of bank owned life insurance and
net gains of $1.4 million in the first six months of 2012, compared to $.6 million of net gains for the same time period of 2011.
Net gains for the first six months of 2012 were driven by net gains realized on sales of investment securities of $.6 million
and $.7 million in gains on the sale of other real estate owned (“OREO”). Net interest income increased slightly during
the first half of 2012 when compared to the same time period of 2011. The net interest margin for the first six months of 2012,
on a fully tax equivalent (“FTE”) basis, increased to 3.33% from 2.85% for the first six months of 2011. The net interest
margin for the year ended December 31, 2011, on an FTE basis, was 2.96%. Although we anticipate a continued flat rate environment
during 2012, we also anticipate that the margin will continue to improve.

42

The provision for
loan losses increased to $9.2 million for the six months ended June 30, 2012, compared to $4.6 million for the same period of
2011. The higher provision expense was primarily due to a loan charge-off of $9.0 million on a shared national credit for an ethanol
plant in western Pennsylvania. In addition to this charge-off, we charged off $1.1 million on a participation loan for a hotel
located in Hazleton, Pennsylvania and $.9 million on a motel located in Salisbury, Maryland. Other than these specific charge-offs,
there has been a leveling in the credit quality of our loan portfolio. Specific allocations have been made for impaired loans
where management has determined that the collateral supporting the loans is not adequate to cover the loan balance, and the qualitative
factors affecting the ALL have been adjusted based on the current economic environment and the characteristics of the loan portfolio.

Interest expense on
our interest-bearing liabilities decreased $4.2 million due primarily to a planned decrease of $171.5 million in average interest-bearing
deposits and a $25.1 million decrease in average debt outstanding. The decline in expense was also due to the continued low interest
rate environment. The Bank’s treasury team continues to monitor rates on our deposits and increases special pricing only
for full relationship customers.

Other operating income
increased $.3 million during the first six months of 2012 when compared to the same period of 2011. This increase was primarily
attributable to net gains realized on sales of investment securities of $.6 million, net gains on sales of OREO of $.7 million,
and the $.7 million one-time, tax free death benefit that accrued in March 2012. The gains were offset by the decline in insurance
commissions, as a result of the sale of the Corporation’s insurance agency subsidiary, First United Insurance Group, LLC,
effective January 1, 2012.

Operating expenses
decreased $1.1 million in the first six months of 2012 when compared to the same period of 2011. This decrease was due primarily
to a $.4 million decline in FDIC premiums attributable to the repayment of brokered deposits. Other miscellaneous expenses declined
by $.2 million primarily due reductions in expenses such as marketing, legal and professional, consulting and postage during the
first half of 2012 compared to the first half of 2011.

Consolidated net income
available to common shareholders was $1.2 million or $.20 per common share, for the second quarter of 2012, compared to net income
available to common shareholders of $.7 million or $.12 per common share, for the same period of 2011. The net interest margin
for the second quarter of 2012, on a fully tax equivalent (“FTE”) basis, was 3.34% compared to 2.95% for the same
period of 2011.

Other operating income
decreased $1.2 million during the second quarter of 2012 when compared to the same period of 2011. This decrease was primarily
attributable to the decline in insurance commission due to the sale of the insurance agency effective January 1, 2012 and a decline
of $.5 million in net gains.

Operating expenses
increased $.1 million in the second quarter of 2012 when compared to the same period of 2011. This increase was due to increases
in other expenses such as marketing, accounting and postage during the second quarter of 2012 compared to the second quarter of
2011.

Net Interest Income

Net interest income
is the largest source of operating revenue and is the difference between the interest earned on interest-earning assets and the
interest expense incurred on interest-bearing liabilities. For analytical and discussion purposes, net interest income is adjusted
to an FTE basis to facilitate performance comparisons between taxable and tax-exempt assets. FTE income is determined by increasing
tax-exempt income by an amount equal to the federal income taxes that would have been paid if this income were taxable at the
statutorily applicable rate. The following table sets forth the average balances, net interest income and expense, and average
yields and rates of our interest-earning assets and interest-bearing liabilities for the six months ended June 30, 2012 and 2011:

43

For the six months ended June 30,

2012

2011

(in thousands)

Average Balance

Interest

Average Rate

Average Balance

Interest

Average Rate

Interest-Earning Assets:

Loans

$

922,665

$

23,983

5.23

%

$

978,836

$

27,188

5.60

%

Investment securities

235,917

3,738

3.19

240,132

4,182

3.51

Other interest earning assets

73,664

134

.37

189,674

239

.25

Total
earning assets

$

1,232,246

27,855

4.55

%

$

1,408,642

31,609

4.52

%

Interest-bearing liabilities

Interest-bearing deposits

$

880,727

3,558

.81

%

$

1,052,249

6,903

1.32

%

Short-term borrowings

35,408

97

.55

40,259

127

.64

Long-term borrowings

206,790

3,833

3.73

227,060

4,701

4.18

Total
interest-bearing liabilities

$

1,122,925

7,488

1.34

%

$

1,319,568

11,731

1.79

%

Net interest income and spread

$

20,368

3.21

%

$

19,877

2.73

%

Net interest margin

3.33

%

2.85

%

Note: Interest income and yields are presented on a fully taxable
equivalent basis using a 35% tax rate.

Net interest income
on an FTE basis increased $.5 million during the first six months of 2012 over the same period in 2011 due to a $4.2 million (36.2%)
decrease in interest expense, which was partially offset by a $3.8 million (11.9%) decrease in interest income. The increase in
net interest income was primarily due to the reduction in the average balances of interest-bearing deposits and average debt outstanding
as well as the reduction in the average rate paid on interest-bearing liabilities. The slightly lower yield on both loans and
investment securities, as funds were reinvested, contributed to the decline in interest income when comparing the two periods.
The reduction in the average rates on interest-bearing liabilities was the primary driver of the increase in the net interest
margin of 48 basis points, as it increased to 3.33% for the six months ended June 30, 2012 from 2.85% for the same period of 2011.
The net interest margin was 2.96% for the year ended December 31, 2011.

The overall $176.4
million decrease in average interest-earning assets, driven by the $56.2 million reduction in loans and the $116.0 million reduction
in other interest earning assets, primarily cash, positively impacted the average yield on our average earning assets. The 3 basis
point increase in yield was driven by the reinvestment of cash into higher loan and investment rates versus the investment into
fed funds.

Interest expense decreased
during the first six months of 2012 when compared to the same period of 2011 due to an overall reduction in interest rates on
deposit products driven by our net-interest margin strategy implemented during 2011 and continuing into 2012, our decision to
only increase special rates on time deposits for full relationship customers, the reduction in the average balance of total interest-bearing
liabilities and the shorter duration of the portfolio. The average balance of interest-bearing liabilities decreased by $196.6
million as management implemented a strategy to right-size the balance sheet by using cash to repay brokered deposits and wholesale
long-term borrowings during 2011. The overall effect was a 45 basis point decrease in the average rate paid on our average interest-bearing
liabilities, from 1.79% for the six months ended June 30, 2011 to 1.34% for the same period of 2012.

The following table
sets forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets
and interest-bearing liabilities for the three months ended June 30, 2012 and 2011:

44

For the three months ended June 30,

2012

2011

(in thousands)

Average Balance

Interest

Average Rate

Average Balance

Interest

Average Rate

Interest-Earning Assets:

Loans

$

910,389

$

11,919

5.27

%

$

955,103

$

13,262

5.57

%

Investment securities

233,939

1,779

3.06

242,533

2,151

3.56

Other interest earning assets

77,540

76

.39

151,318

91

.24

Total
earning assets

$

1,221,868

13,774

4.53

%

$

1,348,954

15,504

4.61

%

Interest-bearing liabilities

Interest-bearing deposits

$

866,885

1,665

.77

%

$

995,149

3,232

1.30

%

Short-term borrowings

35,519

51

.58

39,848

66

.66

Long-term borrowings

206,657

1,887

3.67

218,988

2,275

4.17

Total
interest-bearing liabilities

$

1,109,061

3,603

1.31

%

$

1,253,985

5,573

1.78

%

Net interest income and spread

$

10,171

3.22

%

$

9,931

2.83

%

Net interest margin

3.34

%

2.95

%

Note: Interest income and yields are presented on a fully taxable
equivalent basis using a 35% tax rate.

Net interest income
on an FTE basis increased $.2 million during the second quarter of 2012 over the same period in 2011 due to a $2.0 million (35.3%)
decrease in interest expense, which was partially offset by a $1.8 million (11.2%) decrease in interest income. The increase in
net interest income was primarily due to the reduction in the average balances of interest-bearing deposits and average debt outstanding
as well as the reduction in the average rate paid on interest-bearing liabilities. The slightly lower yield on both loans and
investment securities, as funds were reinvested, contributed to the decline in interest income when comparing the two periods.
The reduction in the average rates on interest-bearing liabilities was the primary driver of the increase in the net interest
margin of 39 basis points, as it increased to 3.34% for the three months ended June 30, 2012 from 2.95% for the same period of
2011.

Provision for Loan Losses

The provision for
loan losses was $9.2 million for the first six months of 2012, compared to $4.6 million for the same period of 2011. The
higher provision expense was primarily due to the aforementioned $9.0 million charge-off of the shared national credit for an
ethanol plant (included in Commercial and industrial (“C&I”) loans) during the first quarter of 2012. Absent this
charge-off, we experienced a continued stabilization in our total rolling historical loss rates and the qualitative factors utilized
in the determination of the ALL, as well as stabilization in the level of classified assets (discussed below in the section entitled
“FINANCIAL CONDITION” under the heading “Allowance and Provision for Loan Losses”). Management strives
to ensure that the ALL reflects a level commensurate with the risk inherent in our loan portfolio.

Other Operating Income

Other operating income,
exclusive of gains, decreased $.4 million during the first six months of 2012 when compared to the same period of 2011. Service
charge income and debit card income both remained stable when comparing the first half of 2012 and 2011. Bank owned life insurance
income increased due to the $.7 million one-time, tax free death benefit that accrued in March 2012. Insurance commissions decreased
$1.3 million due to the sale of First United Insurance Group, LLC effective January 1, 2012. The sale did not have a material
impact on our financial condition or results of operations. We also realized increases of approximately $.2 million in other income
primarily due to increased rental income on other real estate owned. Trust department income also increased $.1 million when comparing
the first six months of 2012 to the first quarter of 2011. Trust assets under management were $612 million at June 30, 2012 and
June 30, 2011.

Net gains of $1.4
million were reported through other income in the first six months of 2012, compared to net gains of $.6 million during the same
period of 2011. The increase in the net gains in the first six months of 2012 was a result of $.6 million in net gains realized
on the sale of investment securities and $.7 million in net gains realized on the sales of other real estate owned. There were
no non-cash OTTI charges on the investment portfolio for the first six months of 2012, compared to $19,000 in OTTI charges during
the first half of 2011. The reduction in OTTI charges throughout 2011 and the first half of 2012 resulted from improvements in
the financial industry, as the collateralized debt obligation portfolio is made up primarily of securities issued by financial
institutions.

45

Other operating income,
exclusive of gains, decreased $.7 million during the second quarter of 2012 when compared to the same period of 2011. Service
charge income and debit card income both remained stable when comparing the second quarter of 2012 and 2011. Insurance commissions
decreased $.7 million due to the sale of the Insurance Agency on January 1, 2012.

Net gains of $36,000
were reported through other income in the second quarter of 2012, compared to net gains of $.6 million during the same period
of 2011. The decrease in the net gains in the second quarter of 2012 was a result of no gains on the sale of investment securities,
gains of $59,000 on the sale of other real estate owned and $39,000 on the sale of consumer loans, offset by a $62,000 net realized
loss on the disposal of fixed assets compared to a $.1 million in net gains realized on the sale of investment securities and
$1.4 million in net gains realized from the sale of the indirect loan portfolio, offset by $.9 million in net losses realized
on the sales and write-downs of other real estate owned in the second quarter of 2011. There were no non-cash OTTI charges on
the investment portfolio for the second quarter of 2012 or 2011.

The following table
shows the major components of other operating income for the three- and six- months ended June 30, 2012 and 2011, exclusive of
net gains/(losses):

Income as % of Total Other Operating Income

Income as % of Total Other Operating Income

For the six months ended June 30,

For the three months ended June 30,

2012

2011

2012

2011

Service charges

24

%

24

%

27

%

25

%

Trust department

31

%

28

%

37

%

28

%

Insurance commissions

0

%

17

%

0

%

17

%

Debit card Income

14

%

15

%

17

%

13

%

Bank owned life insurance

18

%

7

%

9

%

7

%

Other income

13

%

9

%

10

%

10

%

100

%

100

%

100

%

100

%

Other Operating Expenses

Other operating expenses
decreased $1.1 million (5%) for the first six months of 2012 when compared to the first six months of 2011. The decrease was due
to a decline of $.2 million in salaries and benefits resulting primarily from a reduction of full-time equivalent employees through
attrition within the Corporation throughout 2011 and the sale of the insurance company. A decline of $.4 million in FDIC premiums
attributable to the repayment of brokered deposits also impacted the reduced expenses. Other miscellaneous expenses such as legal
and professional, marketing, consulting and postage were also reduced when comparing the first six months of 2012 to the same
time period of 2011.

Other operating expenses
increased $.1 million for the second quarter of 2012 when compared to the same period of 2011. The increase was due to an additional
$.1 million in data processing expense combined with increases in other expenses such as marketing, accounting and postage.

46

The composition of
other operating expenses for the six- and three-months ended June 30, 2012 and 2011 is illustrated in the following table.

Expense as % of Total Other Operating Expenses

Expense as % of Total Other Operating Expenses

For the six months ended June 30,

For the three months ended June 30,

2012

2011

2012

2011

Salaries and employee benefits

50

%

48

%

49

%

50

%

FDIC premiums

5

%

7

%

5

%

5

%

Occupancy, equipment and data processing

21

%

21

%

21

%

21

%

Other

24

%

24

%

25

%

24

%

100

%

100

%

100

%

100

%

Applicable Income Taxes

In reporting interim
financial information, income tax provisions should be determined under the procedures set forth in ASC
Topic 740, Income Taxes (Section 740-270-30). This guidance provides that
at the end of each interim period, an entity should make its best estimate of the effective tax rate expected to be applicable
for the full fiscal year. The rate so determined should be used in providing for income taxes on a current year-to-date basis.
The effective tax rate should reflect anticipated investment tax credits, capital gains rates, and other available tax planning
alternatives. In arriving at this effective tax rate, however, no effect should be included for the tax related to significant,
unusual or extraordinary items that will be separately reported or reported net of their related tax effect in reports for the
interim period or for the fiscal year.

Based on the guidance
in ASC Topic 740, an OTTI charge meets the definition of a “significant, unusual or extraordinary item that will be separately
reported” based on the following:

·

The
impairment charge
related to credit
loss is significant
and is a highly
unusual event for
investments, which
were investment
grade at the time
of purchase and
have become impaired
as a result of
the severe decline
in the economy
and an illiquid
credit market;
and

·

The
OTTI is reported
as a separate line
in the Consolidated
Statements of Operations.

The effective tax
rate for the first six months of 2012 was 20.4%, compared to an effective tax benefit rate of 27.5% for the first six months of
2011.

FINANCIAL CONDITION

Balance Sheet Overview

Total assets were
$1.35 billion at June 30, 2012, a decrease of $42.4 million since December 31, 2011. During this time period, cash and interest-bearing
deposits in other banks increased $1.8 million, the investment portfolio decreased $13.7 million, and gross loans decreased $30.8
million. Total liabilities decreased by approximately $40.9 million during the first six months of 2012, reflecting a decrease
in total deposits of $31.4 million, a $8.0 million decrease in short-term borrowings, due to increased usage of funds in the cash
management product, and a $.5 million decrease in long-term borrowings, due to principal amortization on our FHLB advances. Accrued
interest payable and other liabilities decreased $.9 million. Shareholders’ equity decreased $1.6 million from December
31, 2011 to June 30, 2012 as a result of the net loss recognized during the first six months of 2012.

47

Loan Portfolio

The following table presents the composition
of our loan portfolio at the dates indicated:

(In thousands)

June 30, 2012

December 31, 2011

Commercial real estate

$

318,073

35

%

$

336,234

36

%

Acquisition and development

138,825

15

142,871

15

Commercial and industrial

66,626

7

78,697

8

Residential mortgage

350,983

39

347,220

37

Consumer

33,402

4

33,672

4

Total Loans

$

907,909

100

%

$

938,694

100

%

Comparing loans at
June 30, 2012 to loans at December 31, 2011, outstanding loans decreased by $30.8 million (3.3%). Commercial real estate (“CRE”)
loans decreased $18.2 million as a result of the payoff of several large loans, charge-offs of loan balances and ongoing scheduled
principal payments. Acquisition and development (“A&D”) loans decreased $4.0 million. Commercial and Industrial
(“C&I”) loans decreased $12.1 million primarily as a result of the aforementioned $9.0 million charge-off on a
shared national credit for an ethanol plant. Residential mortgages increased by $3.8 million. The increase in the residential
mortgage portfolio was attributable to a purchase of a pool of loans of approximately $6 million that were being serviced by the
Bank during the second quarter offset by regularly scheduled principal payments on existing loans and management’s continued
use of the secondary market outlets such as Fannie Mae for the majority of new, longer-term, fixed-rate residential loan originations.
The consumer portfolio remained constant with a slight decrease of $.3 million due primarily to repayment activity in the indirect
auto portfolio slightly offsetting new production. At June 30, 2012, approximately 62% of the commercial loan portfolio was collateralized
by real estate, compared to approximately 64% at December 31. 2011.

48

Risk Elements of Loan Portfolio

The following table presents the risk elements
of our loan portfolio at the dates indicated. Management is not aware of any potential problem loans other than those listed in
this table or discussed below.